Two bond funds to buy in case inflation doesn't take off
We could well avoid sustained price rises, in which case these bond funds look a solid bet, says Max King
With bond yields having started to rise but still very low by historic standards, it is hard to find anyone with a positive case for investing in them. Reckless monetary expansion and fiscal incontinence in the UK, Europe and North America are expected to lead to inflation and a consequent jump in bond yields, reflecting falling prices.
Such warnings are not new: in January 2010, bond guru Bill Gross warned that gilts, then yielding 4% for ten-year maturities, “rested on a bed of nitroglycerine” – only to change his mind three years later when yields had halved. Now ten-year gilts yield just 0.8%; surely the wolf is at the door?
Jenna Barnard and John Pattullo, managers of the £190m Henderson Diversified Income Trust (LSE: HDIV) have a more measured view. They argue that “a global cyclical recovery in activity and inflation is predictable after a recession; the bigger surprise was how reluctant US bond yields were to rise in anticipation of this in the second half of 2020”. Furthermore, “we are not convinced that this cyclical rise in inflation is sustainable”.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
They consider that there has been a structural change in the private sector’s behaviour. Households and companies are saving rather than spending or investing owing to slower growth, uncertainty and low inflation expectations; the trend was reinforced by the pandemic. Meanwhile, although the US “has embarked on a massive fiscal stimulus”, other countries “are not in a similar position”.
Europe’s bailout is too small
Yanis Varoufakis, the former Greek finance minister, argues that the EU’s €750bn bailout is too small to make an economic difference. Meanwhile, China, which played a key role in reflating the global economy through credit expansion in 2009 and 2016, is maintaining a restrictive policy.
Barnard and Pattullo acknowledge that inflation is likely to rise in the short term, pointing out that “it is also not unusual to see inflation rise due to base effects following a recession; back in 2010/2011, inflation rose as high as 5.2% in the UK, [around] 4% in the US and 3% in Europe”. But they expect it to fall back by year-end.
“This year’s massive fiscal stimulus in the US is unlikely to be repeated next year.” The one-off stimulus will turn into a “drag” next year as the effects wear off, tempering growth and leading to “a reversal of the inflationary impulse”.
Moreover, “the public sector does not create inflation; it is the private sector through borrowing and lending in the economy. The lack of demand for credit is disinflationary in the long term”.
Banks are cautious lenders
In addition, the financial crisis led to restrictions, both imposed by regulators and through hard-learned self-discipline, which has turned banks into cautious lenders. In Japan, government debt is 220% of GDP, but interest rates, bond yields and inflation are at negligible levels.
Barnard and Pattullo believe that “the indiscriminate sell-off in February, while a shock to the system, provided an opportunity to invest selectively”. If so, HDIV, trading at a 2% discount to net asset value and yielding 4.9%, will continue to generate returns comfortably above inflation and interest rates, having returned 9% last year and 0.8% in the year to date.
Equally attractive is the £140m M&G Credit Income Trust (LSE: MGCI), trading at a 4.5% discount and yielding 4.4%. It returned 3.7% last year, but 2% in the year to date. Launched in late 2018, it has yet to build scale or reputation, although M&G has long been highly regarded for fixed interest. Like HDIV, it has weathered the squall in bond markets well. If the apocalyptic views of the bond bears prove to be as accurate as Bill Gross’s were 11 years ago, then both trusts will continue to generate solid returns for income investors.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
-
Coventry Building Society bids £780m for Co-operative Bank - what could it mean for customers?
Coventry Building Society has put in an offer of £780 million to buy Co-operative Bank. When will the potential deal happen and what could it mean for customers?
By Vaishali Varu Published
-
Review: Three magnificent Beachcomber resorts in Mauritius
MoneyWeek Travel Ruth Emery explores the Indian Ocean island from Beachcomber resorts Shandrani, Trou aux Biches and Paradis
By Ruth Emery Published
-
The industry at the heart of global technology
The semiconductor industry powers key trends such as artificial intelligence, says Rupert Hargreaves
By Rupert Hargreaves Published
-
Three emerging Asian markets to invest in
Professional investor Chetan Sehgal of Templeton Emerging Markets Investment Trust tells us where he’d put his money
By Chetan Sehgal Published
-
What to consider before investing in small-cap indexes
Small-cap index trackers show why your choice of benchmark can make a large difference to long-term returns
By Cris Sholto Heaton Published
-
Why space investments are the way to go for investors
Space investments will change our world beyond recognition, UK investors should take note
By Merryn Somerset Webb Published
-
Time to tap into Africa’s mobile money boom
Favourable demographics have put Africa on the path to growth when it comes to mobile money and digital banking
By Rupert Hargreaves Published
-
M&S is back in fashion: but how long can this success last?
M&S has exceeded expectations in the past few years, but can it keep up the momentum?
By Rupert Hargreaves Published
-
The end of China’s boom
Like the US, China too got fat on fake money. Now, China's doom is not far away.
By Bill Bonner Published
-
Magic mushrooms — an investment boom or doom?
Investing in these promising medical developments might see you embark on the trip of a lifetime.
By Bruce Packard Published