Bonds are back

BIPS and MGCI may benefit from rising interest rates….

 
Splitting your portfolio 60:40 between stocks and bonds has long been seen as a simple way of producing a relatively low risk return on your investment. The past decade has made it much harder to agree with this piece of common wisdom. With interest rates only hovering slightly above zero, lower risk government bonds have often failed to provide satisfactory returns.

The result of this was a widespread move up the risk scale, with equities acting like bond proxies for many investors. In the UK, firms like Unilever and Diageo exemplified that role. Shareholders hoped to get a mix of relatively stable capital appreciation, as well as reliable dividend payments. But in many instances these proxies could not provide the sense of security or yield investors were looking for.

Another option is to move into higher yielding fixed income products. Investment trusts like Invesco Bond Income Plus (BIPS) provide exposure to this segment of the market. BIPS has a dividend yield of 6.1% as of April 20th and has proven relatively adept at preserving capital in a volatile couple of years.

Of course, these dynamics may be shifting again. Inflation is pressuring central banks to raise interest rates and the next couple of years may see a return to rates we haven’t seen in over a decade.

For fixed-income investors this is likely to be a bittersweet process. Rate hikes provide opportunities to earn higher yields on new investments but also put downward pressure on bond prices. The further away the maturity date, the greater the price drop.

BIPS is better placed to deal with these changes than some fixed-income funds. High-yield bonds in general are less sensitive to interest rate changes than other areas of the fixed-income market. This is because of the higher coupon paid and the generally shorter maturity. While the value of its portfolio is still likely to fall as interest rates rise, the high yield should also provide some cushion.

Another fixed-income trust that may appeal to investors looking for exposure to the market is M&G Credit Income (MGCI). The trust has an attractive quality which may mean it actually benefits from rate hikes.

Approximately 85% of its holdings are in floating rate instruments. As the income these produce rises in line with interest rates, they are not subject to the same price-yield dynamic that fixed rate bonds are. MGCI’s managers also use Gilt futures to reduce the duration of their portfolio.

Beyond the composition of the portfolio, the trust has access to asset manager M&G’s huge range of resources in the fixed income space. In the past couple of years this has allowed them to invest in more illiquid, complex deals that have provided a high yield with relatively low credit risk.

None of this is to say that BIPS or MGCI are sure winners but, as the past two decades have shown, market dynamics can change very quickly. A rise in interest rates is likely to have wide-ranging effects and investors will have to think about how to position their portfolios accordingly.
 
_Disclaimer

_{This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.}