Bond yields: Like a broken record

Bond yields at all-time lows? Darius McDermott, MD at Chelsea Financial Services, reckons that sounds like a broken record.

Bond yields: Like a broken record

We’ve had all sorts of broken records this month. Usain Bolt was the first person to win the 100m and 200m races three Olympics running, a Georgian weightlifter hoisted an unbelievable 472kg, and three Estonian women became the first ever identical triplets to compete in the marathon.

Equally exciting, UK government bond yields have hit all-time lows.

In case you missed my sarcasm, the problem is that low bond yields are no longer something to write home about (if indeed they ever were). The fact that the yield on 10-year UK government bonds (gilts) closed at a record low of 0.518% earlier this month1 doesn’t make many headlines.

Demand vs supply

Bond yields have been more or less falling for the past 30 years. Back in the early 1980s they had crept above 15%2. Even at the start of this year they were up around 2%3. Brexit put paid to that. Gilts are one of the world’s safe haven assets and in times of uncertainty, investors flock to them as a ‘reliable’ place to park their money.

This demand pushes up their price, which pushes down their yield. Added to that, the Bank of England has just ramped up a stimulus program that includes buying lots more bonds -both those of the UK government and UK companies – so this pattern is likely to continue, at least in the medium term.

Income

With interest rates close to zero for more than seven years now, investors hardly need telling that income is hard to find. Savings accounts paying more than a couple of percent per annum are a distant memory. Even the likes of Santander, which previously had one of the best accounts going in the current climate, halved its rate from 3% to 1.5% following this month’s interest rate cute.

So where to now if you want to earn an income?

For my part, I’d much rather be in equities at the moment than bonds. Yes, the stock market is more volatile and higher risk, and dividends are not guaranteed, but the best active fund managers are still finding good quality companies that pay stable, growing dividends. And at least in equities you have the chance of your money also appreciating in value.

Three Elite Rated UK equity funds that focus on income:

The Fidelity Enhanced Income has a historic annual yield of 7%4, putting it streets ahead of most other equity income funds. Its managers achieve this by their slightly unusual strategy of selling a special type of contract on some of the stocks they own, which pays them an additional income. This strategy does tend to reduce total returns, as it trades off some potential capital growth for that extra income, but it also reduces volatility.

With a historic annual yield of 4.6%5, the Liontrust Macro Equity Income is another solid contender in this space. The managers aim to identify, at an early stage, major political, social and economic themes, and then invest in companies they believe have the potential to benefit from those themes – as well as avoiding sectors they believe will be negatively affected.

Rathbone Income has a track record of rising income payments in all but one of the past 10 years6. Its historic annual yield is 3.4%7, and it focuses on generating both income and some growth. The manager is not constrained in terms of what size companies he can buy or how much he can invest in certain sectors, which means this fund also provides some nice diversification away from ‘traditional’ income paying stocks.

 

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.

 

1Rathbone, Review of the week email newsletter, 15/08/2016

2,3Trading Economics, UK government bond 10-year yield, 1981–2016

4,5,7FE Analytics

6Rathbone Income, website fact sheet

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