The volatility in the gilt market has delivered much pain for mortgage and pension professionals, but for some investors it has been a time of plenty.
FTAdviser knows of one fund manager who made a profit of 17 per cent on one gilt trade in 24 hours. That manager didn't wish to be named in this article.
The intention had not been to flip the asset so quickly, but such has been the volatility in the asset class that the price had risen stoutly in twenty four hours, and the potential for a rapid profit proved too tempting.
Those events happened in the immediate aftermath of the “mini budget” under the brief Prime Ministership of Liz Truss, and the gyrations in the market for UK government debt at that time were presented as being without precedent.
Yet the very high yields that were born of Trussonomics resurfaced in the gilt market at the start of June, with yields on some UK government debt actually rising above the levels seen at the time of the mini budget.
Given such volatility, how should an adviser or wealth manager think about the role of gilts in portfolios going forward?
It is first worth examining why bond yields may be rising.
A rising bond yield in the first instance signals a lack of desire to own the asset, because if yields are rising then prices are falling.
And bond prices may be falling because investors are more confident about the economic outlook and so would rather own riskier assets such as equities, or else it can be the result of investors believing that inflation will rise so stoutly that the present value of the income from a bond will be withered by the onset of very high inflation.
The tax cuts and spending plans of Truss’s “mini-budget”, and the apparent view of that government that tax cuts in all circumstances raise revenue, spooked many bond investors who believed the plans were not credible and would lead both to much higher inflation. Conversely, a government facing a revenue shortfall which would necessitate the issuing of more bonds, creating a supply vs demand imbalance that would be expected to push the price of bonds downwards.
Those factors are exacerbated by the Bank of England selling off its holdings of gilts at a rate of hundreds of millions of pounds per month, as part of its plan to unwind the quantitative easing programme which involved buying bonds.
Bumpy ride?
But while understanding the reasons for sharp movements in gilt yields may help one to profit in the short-term, as happened with the fund manager mentioned above, much of the theory which underpins how wealth managers construct portfolios is predicated on gilts being a lower volatility asset class, designed to mitigate the impact of equity markets. So while there may be short-term gains, longer-term questions arise around how to construct a portfolio.
