Bond markets are undergoing a historic sell-off as central banks gear up to fight inflation and investors brace for higher interest rates.
Few parts of the bond market have been spared from the falling bond prices. The Bloomberg Global Aggregate index, a broad market-cap weighted index made up of government and corporate bonds, is down more than 7% year-to-date.
Performance of Bloomberg global aggregate year-to-date
Source: FE Analytics
The volatility in bonds has accelerated over the past several weeks as markets continue to re-price most parts of the asset class in anticipation of faster rate hikes by the central banks.
Rupert Thompson, chief investment officer at Kingswood said: “10-year US Treasury yields jumped 0.35% to 2.50%, while 10-year UK gilt yields increased 0.20% to 1.67%.
“Yields have now risen as much as 1.0% and 0.7% in the US and UK since the start of the year, leading to hefty losses of 6.5% and 7.9% respectively.”
Much of the latest bond turmoil came after US Federal Reserve chairman Jerome Powell’s statements that suggested he wanted to return US monetary policy to a neutral stance quicker than previously thought.
Thompson said that a 0.5% rate hike “now looks likely” at the Fed’s next meeting in May and he expects rates will end the year at around 2.5%, up from 0.5% currently.
Amidst the rout in the bond market, many of the industry’s largest bond funds have lost billions of pounds in value since the start of the year.
Below is a table of 20 of the biggest bond funds & their returns year-to-date in sterling terms.
Source: FE Analytics
The FE fundinfo five-crown rated £52.3bn Pimco GIS Income fund, the largest bond fund across all the sectors, is down 5.6% year-to-date. Although it has dipped to the third quartile over the past three months, it remains top quartile over a longer time horizon of five years.
The second-largest bond-fund and largest passive strategy in the table was also hit significantly, down 6.2% year-to-date. The Vanguard Global Bond Index is a popular choice amongst many low-cost seeking investors looking to replicate a passive 60/40 equities/bonds portfolio.
The fund with the heaviest losses in the list above was the Pimco GIS Diversified Income fund, which is down 9.4% year-to-date in sterling terms – putting it in the bottom quartile for performance amongst its peers. Like the previous Pimco fund, over the past five years it remains top quartile.
One might have expected the riskier end of the credit spectrum to sell-off more aggressively than the more diversified bond funds – but this sell-off has been unique in that it is more of a re-pricing of bonds rather than a deterioration of credit conditions and rising corporate defaults, so far.
The Robeco High Yield Bonds fund was another notable giant bond fund that suffered a 5.6% decline in value, albeit on-par with most of the other titans.
The giant bond funds with the lowest losses year-to-date have been the iShares China CNY Bond UCITS ETF and the iShares $ Treasury Bond 1-3yr UCITS ETF.
One reason for the relative strength of Chinese bonds could be attributed China’s central bank, which has not made any drastic monetary policy changes in recent years.
Contrast this to the swiftly changing monetary policy stance of the US central bank which a year ago indicated no rate increases until at least 2024 but is now telegraphing almost eight rate hikes by the end of this year.
Meanwhile short-dated US Treasury bonds have been relatively insulated from the repricing of inflation as less of their future value needs to be discounted by higher interest rates.
However, the losses are not just limited to the large bond funds. Over 95% of all bond funds across the Investment Association sectors are down year-to-date. Below are the 20 worst-performing bond funds year-to-date, in sterling terms.
Source: FE Analytics
While most bond funds have suffered losses in 2022, more than half of all the bond funds in the universe (477) are down 5% or more.
If one assumes these bond funds had an average yield of roughly 2% at the beginning of the year, it would mean that more than two years of income has been wiped off the value of these bonds in less than three months.
Out of 845 bond funds across all the bond sectors in the IA universe, just 36 of them have positive returns year-to-date in sterling terms.
But that is not to say that the positive returns were meaningful in absolute terms, because fewer than half of these bond funds delivered returns above 1% year-to-date, as highlighted by the table below.
Source: FE Analytics
Most of the funds in the list hold either inflation-linked, short-duration or Chinese bonds. Inflation-linked bonds have fared well as these compensate investors for higher rates of inflation.
Given that higher interest rates hurt longer duration bonds, on a relative basis short-duration bonds have held up well amidst rising interest rate and inflation expectations.