Interest rate rises, for example, have a greater impact on bonds which have a low default risk such as government bonds. Long-dated bonds are also more sensitive to the changes in interest rates, whereas with short-dated bonds, the focus is on the return of capital. High-yield bonds tend to be more sensitive to the outlook for the company or the economic conditions, so they are less sensitive to interest rate movements. Each bond is unique in its sensitivity to each of the factors.
This means that the market is now constantly changing and adjusting to new bits of information, and there are still plenty of potential investment opportunities to make money from investing in bond markets. While interest rates are expected to rise, the economic backdrop remains very benign and the global economy looks stable and fairly healthy for the first time since the financial crisis.
Low defaults
Even with interest rates rising, they are coming from a low base, with many companies having already renegotiated their debt at these low levels. This is all good for corporate bonds as there should be a lower level of defaults. Companies are able to make the interest payments, and even if interest rates do go up higher than expected, they will still remain relatively low.
Over the years bond managers have developed new tools to ensure they can make money for investors in all market conditions. The use of derivatives means they can now profit from rising yields as well as falling ones. Managers can also reduce interest rate risk by buying short-dated bonds.
There are also many niche sectors and areas of the bond markets such as asset-backed securities, which offer more attractive returns for taking a similar risk. This area of the market is not sensitive to interest rates because the focus is more on the underlying assets generating the yield. This is an important differentiator to the more mainstream corporate bond sector, which still has some sensitivity to interest rates.
With the bull market over, a manager’s skill is going to be worth a lot more in the coming months and years. The key to success in investing in bonds is making sure you have the right fund for the job. When looking for a manager and fund, it is important to find a team that can be flexible, can diversify their portfolio and has the mandate to run a dynamic fund.
Adrian Lowcock is investment director at Architas
