Via Financial Times

They say no one rings a bell at the top of the market. Major shifts in investment patterns are typically easy to identify in hindsight but hard to see happening in real time.

The current profound shift in thinking about bonds — their direction and function in portfolios — may be an exception. For many fund managers and wealth advisers, the precise point for a rethink arrived on September 13, 2019, when the German tabloid Bild doctored an image of Mario Draghi — then the president of the European Central Bank — to represent him as a vampire. The front-page image of the fanged “Count Draghila” suggested the central bank was sucking the blood out of German savers’ bank accounts with its new package of easing measures.

The broader message was pretty typical of the abrasive German tabloid press. But this image of a sinister-looking Mr Draghi felt more personal, angry and urgent. If you ask a fund manager when they started seriously to worry that negative interest rates had really gone too far, this is often the answer.

Tremors were there before that, such as when Swiss bank UBS started to charge wealthy customers for deposits, or when Denmark’s Jyske Bank started paying customers to take out mortgages. But something about the vampiric Mr Draghi rather sticks in the throat, if you will pardon the pun.

Didier Saint-Georges, a managing director at French fund house Carmignac, described the imagery as “obscene”. But it has also proven to be one reason to think more carefully about what supposedly safe bonds really do for an investment portfolio when support from central banks sweeps prices so uncomfortably high.

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Feasting on bonds made sense while central bankers were still slashing rates and effectively promising consistent monetary support, he said. Now, though, policymakers are calling more loudly for fiscal help and a public backlash is building. “Historically, especially in the past 10 years, if you had a balanced portfolio of equities and bonds, bonds were a terrific part of your portfolio construction because, not only were they doing well, but they were also a hedge to equity risk,” he said.

Now, the assumption that interest rates can keep falling in pursuit of higher inflation, pulling up bond prices with them, is crumbling. Relatively small pullbacks in prices can be painful and the capacity for further gains in bonds in the event of a wobble in stocks is seen as limited.

Mr Saint-Georges predicts that “2020 is not necessarily going to be a binary thing — crisis or not crisis”. But he believes it will bring a profound reshuffle in how people think about the right portfolio construction. Good quality emerging-market debt, emerging-market currencies and gold could come more into favour as hedges for when stock markets turn sour, he said.

The New-York based fund group BlackRock also said in November that it has been forced to reconsider the role that maxed-out government bonds play as “ballast” in portfolios. The see-saw relationship between stocks and bonds that has become familiar over the past two decades is at risk of breaking down. With their super-skinny or even negative yields, European and Japanese government bond markets are likely to play a “diminished role”, it added.

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At BlueBay Asset Management, chief investment strategist David Riley also said flows over the past year suggest a cooling towards European government bonds and a greater weighting towards good quality corporate debt. Yields are hardly spectacular, but they are at least positive. US government bonds could still rally if equities hit the skids or an unexpected recession arrived, he said. “But it’s a bigger issue in Europe. How much more negative can Bunds go?”

Mr Saint-Georges, who is a keen climber, acknowledges that stepping back from core government bonds too aggressively or too early could be painful. But, he said, “it’s one thing we know in the mountains. The coldest part of the day is just before the dawn. [Central banks are] not throwing in the towel yet. Nothing is obvious, nothing is for sure, but we don’t want to be late because the stakes are rising.”

This may not be the time to pounce, but it is the time to think. Expect more of this from fund managers in 2020.