Don't Go for Broke on Bond Buys

Article excerpt


ITH world equity markets tumbling, a transfer of funds from shares to bonds is tempting. But even the wealthy individual, with sufficient assets to construct a diversified portfolio, should think twice before committing more money to fixed-income securities, experts say.

The attraction of bonds today is clear: share prices are under pressure worldwide. On Wall Street, the Dow Jones industrial-stock index dipped below 10,000 late last month, back to its April levels, down on the year and sharply below the highs over 11,000 seen in May.

In London, the FTSE 100 share index is falling and in Tokyo the Nikkei 225 share index has been dropping steadily since the spring, with no sign of any recovery.

Many analysts are still predicting a worldwide rally as the global economy shrugs off its weakness. Others, however, are more pessimistic, unconvinced that the international economy will recover any time soon and, therefore, that a new bull market is just around the corner.

For investors taking this more gloomy view - which implies that share prices will stagnate or fall further - a move into bonds is superficially attractive and a host of new funds has been launched to cater for the demand. However, bonds are looking expensive by historical standards and they are not as risk-free as is sometimes assumed.

The yield on the benchmark 30-year US Treasury bond has already fallen from almost 6% in the spring to about 5.4% now - implying a substantial in-crease in price.

The yield on the benchmark 10-year UK gilt has dropped from more than 5.3% in the early summer to about 5% now. And the yield on the benchmark 10-year Japanese government bond has fallen to 1.4%.

"There's no great value now in government bond markets where it's quite difficult to find a major market yielding much more than 5% anywhere along the yield curve," says Dick Howard, director of research at Julius Baer Investments. "If you look at the US, the euro area, the UK or Japan, 5% is pretty much tops."

These are all risk-free investments. Anyone buying government bonds issued by one of the leading industrial nations, and holding them to maturity, will receive a guaranteed return.

However, only the highly pessimistic - expecting little recovery for the world economy until next year or even later - are likely to find government bonds attractive at current levels.

For an investor expecting an economic recovery in six to nine months, it is hard to see much value in bonds, compared with equities. This is true even if jittery professionals continue to look for safe havens for their money. "Yields are low in historic terms, so the scope for capital gains is fairly modest from here. However, bonds should be underpinned by a flight to quality," says Nick Stamenkovic, European bond strategist at Nomura.

Global funds that exclude the exceptionally low-yielding Jap-anese government bonds are more attractive, but it is corporate bonds, where the risk of default is far from negligible, that are more likely to be of interest - along with government bonds issued by emerging-market nations, which could also default.

However, investors need to be wary of the many new bond funds offering very high yields launched lately by fund management companies with little experience of the asset class. There is a danger of losing capital as bond-issuing companies default on their debt obligations; the capital losses offsetting or even wiping out the income. …