Bonds offer shelter in turbulent times

Bond funds have not produced a very exciting performance this year but cautious investors are now looking to them as a safe haven in turbulent times

The current tensions in the Middle East, combined with the recent stock market shakeout, mean that the steady but unspectacular qualities of bonds are once again coming to the fore.
Paul Abberley, chief investment officer of fixed income at ABN Amro Asset Management, says sound bond returns offer a solid anchor for investors’ portfolios amidst choppy stock markets, soaring commodity costs and crumbling currencies.
One thing which could threaten this rosy scenario is inflation, which is generally bad for bonds. But Mr Abberley says the fears have been overdone. “Headline inflation may rise because of higher oil and commodity prices, but there is no evidence that inflation is embedded.” Instead, he says, the dominant mindset is for disinflation, as demonstrated by the constant price wars among retailers.
Justin Modray, of Bestinvest the independent financial adviser, says bonds have a number of things going for them. Over the long term they tend to produce a better return than cash deposits but they are less risky than shares.
There are different levels of risk within the bond universe, with government bonds, or gilts, at the low risk end of the spectrum and high-yield, low-quality ‘junk’ bonds at the other. Skilful managers of bond funds can chisel out extra value by moving up and down the risk scale.
Income seekers value the regular payments of interest that bond funds deliver and they also provide valuable diversification from an equity portfolio.
However investors should remember that there is always a trade-off between risk and reward. If bond funds are generally less risky than equity funds they also tend to produce less exciting performance. In the past three years, which have been very good for shares, UK equity funds have produced an average return of 52 per cent, while UK corporate bond funds have returned just 7 per cent. Over five years, which includes a large slice of the recent bear market, equity funds were still ahead, with a return of nearly 27 per cent, compared with only 20 per cent for bond funds.
As always, it is worth pointing out that past performance is no guarantee of future performance, though UK shares have outperformed Government bonds over 20 and 50 years.