A 'sleeping giant' of many advisor portfolios may well be duration. That bonds act as ballast to portfolios has been accepted logic for many years.
When the economy weakens, corporate profits fall and therefore equities do too; however, at the other end of investor portfolios bonds strengthen, or so the logic goes, as fixed income streams become more attractive during times of economic uncertainty.
This relationship is under pressure, predominantly due to the eye-watering valuations both bonds and equities are trading at compared to longer-term averages.
The long-term average yield of an index of UK government bonds stood at 4.8% per annum in the decade up to June 2008, with accompanying duration ranging from six to nine years.
Under such conditions, a 2% move up in gilt yields would have caused a painful 12%-18% loss to investors. With duration on the index at 11.6 years today, an equivalent 2% move and investors would be down almost 25%.
One can only hope investors are appreciating this risk. But despite the potential downside risk, such gilt exposure could be exactly what investors need in a balanced portfolio.
Uncorrelated returns from equity markets are rare to find, and bonds, and more pertinently duration, have tended to be a fairly reliable source of diversification and positive returns when equities fall.
In fact, despite some signs of increased correlation towards the beginning of 2018, government bond markets have defended relatively well compared to credit markets, further strengthening the case government bond yields remain a safe haven despite such high valuations.
There are also investors of the view the UK, driven in no small part by continuing Brexit uncertainty, is in for a prolonged period of low growth and low inflation.
Against such a backdrop, gilt yields may even test the 2016 lows again, therefore offering attractive capital appreciation potential for investors at current levels.
In my view, the risk of high duration/large gilt exposures in portfolios appears relatively one-sided for now, and investors would do well to consider positioning their portfolios into alternative parts of the fixed income market.
Paul Angell is investment research analyst at Square Mile Investment Consulting & Research
• Structurally, gilts provide an uncorrelated return stream from equities
• UK economic uncertainty could lead to more downward pressure on gilt yields
• Duration on UK government bonds is eye-watering
• Compensating yield for the risk remains paltry