A significant milestone and a turning point?

As the UK gears up for its first-ever Platinum Jubilee, the Rathbone Ethical Bond Fund is celebrating its own historic milestone. Fund Manager Bryn Jones looks at what might lie ahead as bond markets move into a new cycle and the transition towards a greener, more circular economy gains still more momentum.

By 31 May 2022

I may not (yet!) be the longest-serving bond manager in history, but I have been managing our Ethical Bond Fund for a fair old whack. In fact, for 18 of the 20 years since it first launched. I’m thrilled it’s celebrating this milestone and particularly proud that it’s matured from being a minority taste to become a mainstream investment choice.

I’ve been around long enough to understand that financial markets don’t keep on performing in the same way year after year. And a lot of the things that have been driving bond markets for a long time are changing right now. I keep on being asked (in gloomy tones): is this the end of the great bond bull market that’s been around since the global financial crisis (GFC)?

Yes, bond prices may fall further and yields increase more as the interest rate cycle turns and central banks hike rates higher than they’ve been for many years. That presents challenges. But higher yields offer opportunities too.

If you compound those higher yields over decent periods of time, they can deliver attractive returns. And of course higher yields are positive for income-hungry investors. As I recently explained, the number of people on our planet is increasing and they’re also getting older. That increases demand for things that help boost people’s post-retirement income. Bonds offering decent yields can help address that demand. I view them as particularly attractive because they can offer safer income streams than other asset classes. Equity dividends can suddenly get cut when equity markets run into trouble. There’s much less risk of income-slashing when it comes to higher quality bond investments.

At the same time, the turn in the rates cycle and central bank reversal of quantitative easing (QE) bond-buying programmes introduced after the GFC suggest that bond investments will start to offer a better safety net against equity market volatility. Ever since the GFC, low rates have contributed to most equity markets rising consistently, while QE pushed bond prices up and their yields down. Now that rates are rising and QE is being reversed, bonds and equities have been selling off at the same time. But when the ultra low yields and QE programmes are unwound, I believe bond price movements will once again uncouple from equities, offering protection when stocks fall.

We’re now getting to the point where the yields on many important government bonds are in positive territory (at least, if you don’t adjust for inflation). Assuming bonds go back to being uncorrelated with equities, that means bonds can once again provide an income generating insurance policy for equity portfolios.

There’s been lots of nervousness about fixed income investments this year. But I think even those who have been sitting on the sidelines might want to consider wading back into bond markets at some point in the next six to 12 months, especially given bonds’ potential to deliver valuable defence against equity market uncertainty.

Sustainability takes centre stage…

The turn in the rates cycle isn’t the only big change that I think lies ahead. Over the next 10 to 20 years, I think the transition to a lower carbon, more circular economy in which we’re much more sensible about how we use the world’s resources will gain even greater prominence.

Governments, businesses and broader society will increasingly prioritise initiatives to reverse or at least slow down humans’ harmful impact on our planet. Tighter regulation and consumer reluctance to engage with businesses that are lagging will make life much more difficult for the laggards.

Simply put, businesses without decent ethical and sustainability credentials will increasingly risk become failing businesses. And I think there’ll be wider recognition that focusing on these credentials can help identify secure ‘future-proofed’ investments. The team that works with me to manage our fund is hugely experienced in analysing environmental, social and governance (ESG) metrics and cutting through ESG ‘window dressing’ to work out whether lofty long-term goals will actually translate into meaningful short-term action. I firmly believe this gives us an extra edge that’s going to keep on helping us to identify future potential winners and steer clear of potential flops. My co-manager Noelle Cazalis and I discuss this ‘edge’, and other issues, in a recent Akademia interview, which you can watch in full here.

Importantly, as bond holders we can put money behind projects and initiatives that bring real environmental and social benefits. We invest in a lot of not-for-profit organisations (like community conservation projects and social housing) that just aren’t an option for equity investors who are much more focused on opportunities that generate higher returns. We don’t need borrowers to make big profits: we just need them to generate healthy and sustainable cash flows so they can make their coupon payments and pay back the principal we have lent.

Adaptability is a critical component in the search for longevity. In the 20 years since the Ethical Bond Fund launched, we’ve kept on adapting to changing financial market conditions and to broader changes in the world at large.

I firmly believe this approach is going to keep our fund fit for purpose over the next five, 10 and even 20 years. Happy long weekend everybody!