World Bond Markets screen

What does the chart show?
That investors enjoying a bond fund heyday in recent years experienced a sharp jolt back to earth in May, as bond prices slumped and bond funds slid to the bottom of the pile for performance.

Open-ended bond funds delivered the worst performance of any type of fund on average, according to data from provider FE, with the average sterling high-yield bond fund returning less than any other Investment Association (IA) sector.

After decades of rising bond prices fuelled by record-low interest rates and central bank bond-buying programmes, the rising tide lifting all bond fund boats appears to have turned.

The average sterling high-yield bond fund lost 0.6 per cent between April 30 and May 30 2018. The average global emerging market bond fund lost 0.6 per cent over that time.

The average sterling strategic bond fund lost 0.4 per cent. Over the month the FTSE 100 and FTSE All Share both returned 2.8 per cent. Equity funds in general performed significantly better than bonds. The top-performing funds were grouped in the North American Smaller Companies sector. The average fund there returned almost 9 per cent.

What’s gone wrong with bonds?
Since the global financial crisis you could have invested almost anywhere in bond markets — government bonds through to high yields — and you would have enjoyed equity type returns,” says Gavin Haynes at Whitechurch Securities.

“But past performance is no guide to future returns and this is certainly the case with bond funds going forwards,” he says.

After several decades in the sun, bond prices are finally falling due to fears that rising interest rates around the world, monetary tightening programmes and rising inflation will send money flooding out of bonds and into higher yielding investments elsewhere.

European bond prices have also fallen in recent weeks due to political turmoil in Italy, which has made investors wary of European debt.

Rob Morgan, pensions and investments analyst at Charles Stanley, says: “A few negative trends have been affecting bonds so far this year. An uptick in economic growth forecasts, and the prospect for inflation to inch up a little has taken the shine off the asset class.”

Bond prices — and yields — are affected by interest rates and inflation. Rising interest rates depress the prices of bonds in the market because yields on other investments rise, and existing bonds in the market are worth less to investors.

Meanwhile, the fixed value of a bond interest payment is worth less when inflation rises, eroding the bond’s yield.

So should you shun bonds?
No. Bond complacency might be over, but the asset class still has a role to play in investment portfolios.

“Bonds are important for diversification purposes, so if you want to limit volatility in a portfolio they are still a means of doing that as they are move in a different (and sometimes opposite direction) to stock markets,” adds Mr Morgan.

“However, for those who have the capacity to absorb the stock market ups and downs in investing for ten years or more, bonds are likely to dilute portfolio performance and be an unnecessary impediment to overall returns.”

In the short and medium term, the high price of many bonds makes them vulnerable. Combined with low yields, many investors may feel the income they are paying is not enough to compensate for capital loss.

Mr McDermott says: “Bonds are not as safe as they used to be.

“But, bonds can still play their part in a portfolio as they do add diversification and a source of income. I’d just be underweight them at the moment. There are pockets of value to be found and different types of bond that are less sensitive to interest rate rises.”

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