Investment - Articles - Investors should look for alternatives to government bonds


 As government bond yields decline investors should look beyond their perceived ‘safe haven' status to alternative assets in a bid to ride out market volatility says HSBC Global Asset Management.

 Core government bonds have been a success story of recent years, boosted by extraordinary policy responses which have favoured the asset as base rates hit historic lows and quantitative easing resulted in significant demand. The UK, US and German markets have returned 46.24%, 66.80% and 43.28% respectively (nominal GBP terms) over the last five years compared to just 18.60% in equities (MSCI World) and 2.73% in commodities (DJ UBS Index) and -9% in Property (IPD Index)*.

 But now yields on government bonds have hit multi-year lows in these three markets and with inflation likely to rise, in the medium term, government bonds are likely in HSBC Global Asset Management's current view, to deliver low to negative real returns. Typically the case for core government bonds in managed solutions appears irrefutable. Aside from diversifying assets they potentially can produce decent returns with lower volatility than many other asset classes. But given the current situation, investors with high bond exposure are effectively saying while they cannot tolerate short term fluctuations in their capital, they can endure potential losses over the medium to longer term.

 Alec Letchfield, CIO Wealth (UK) HSBC Global Asset Management says: "When uncertainty is high, core government bonds warrant a place in a balanced portfolio. But it is the returns angle that concerns us. Whilst market participants have a habit of extrapolating forward recent returns, in reality it is the current valuation of an asset that generally dictates future returns. Despite a year marred by negative news, it is proving to be a respectable period for risk asset returns - over the past 12 months global equities have provided returns in excess of 10.12%**. While the economic backdrop remains difficult, and we believe this is not going to change anytime soon, looking at the world economy now, we feel we may be seeing some tentative signs of improvement. The announcement of the ECB's OMT bond buying programme appears, we believe to have removed a significant near-term tail risk, reducing the risk premium and allowing equities to rally."

 Letchfield asserts that multi-asset investors should look to identify assets with similar characteristics to government bonds; that is lower volatility assets which typically conserve capital at points of market stress and which can potentially generate an above average income. He says: "We would highlight the real estate sector, infrastructure, emerging market bonds and higher yielding equities of companies with strong balance sheets. Whilst by no means perfect on all of these measures, especially as the correlation of these assets with risk assets such as equities can increase at points of market stress, they do however provide useful alternatives. Both real estate and infrastructure represent real, tangible assets, which aim to generate yields and have diversifying characteristics in a portfolio. Emerging market debt has historically performed well and the gap between their yields and core government bonds has narrowed of late."

 Arguably though, this is justified with the fiscal positions of many emerging economies and corporations currently looking better than that of the western world notes Letchfield. He says: "With emerging market currencies also likely to appreciate over time, holdings in emerging market debt held in local currency terms are still attractive. Equities with above average yields and strong balance sheets are also presently attractive. Equity valuations are typically low compared to past history and certainly versus core government bonds. Incorporating this with above average yields and solid finances typically could help to dampen volatility even further. We believe given the current climate of additional short-term volatility, having a lower level in bonds may result in potentially longer term returns, provided investors are able to tolerate this additional volatility in the short-term and are willing to invest for the longer term."

 *Source: All figures in GBP to end of October. IPD data end of September

 **One year return of MSCI World index in GBP, as at end of October 2012

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