Fund managers are like kids in a candy shop as developed market bond yields rise, but there are likely to be casualties in other asset classes.
- High bond yields are drawing in fund managers
- Other high income sectors are being crowded out
- With so much choice, investors can afford to be picky
Fund managers are increasingly tempted by the generous yields on offer in developed market government bonds. Bagging 5-6% for a UK or US bond seems like a reasonable trade in the current environment. However, higher bond yields are damaging certain sectors of the stock market and may also hurt other parts of the bond market.
Yields have finally ticked high enough to tempt many investors. Paul Flood, head of multi-asset investment at BNY Mellon, says: “We can now lock in 6% yields at the long end of the gilt market, and we used to only be able to get 0.5%. It's a fantastic world for an income investor.” Bond markets, particularly in the UK, appear to be pricing in a lot of the risks.
But there will be areas that might suffer as a result. As bonds become more appealing, other high income sectors are likely to be crowded out. This is already evident in certain sectors. Real estate companies are down 7.2% over the past month, while utilities are down 2.3%. Financials are also struggling as investors anticipate weaker loan growth as borrowing becomes more expensive.
This may disproportionately affect certain markets. As a high income market, the FTSE 100 looks vulnerable. Russ Mould, AJ Bell investment director, says: “The 10-year gilt yield is 5.40%, while the dividend yield on the FTSE 100 for 2026 is 3.3%, based on aggregated consensus forecasts for all of the index’s members. Any investor who is nervous about the economic outlook and feels that inflation is not about to break out on the upside could start to look toward fixed income and away from equities as a result, especially if they feel their portfolio needs a little capital protection.”
There is also a question over whether it starts to crowd out certain parts of the bond market. For example, with spreads low, could corporate bonds start to look unappealing? Emerging market debt has been a significant beneficiary of worries over the fiscal responsibility of developed market governments, but it might have less appeal in an environment of high yields. Will it start to impact the popularity of debt issued by the technology companies? SpaceX has been the latest company to see its debt levels widen out in response to worries over its borrowing spree.
The message is that with so much choice, investors can afford to be picky about where they derive their income. If they can get 5-6% with zero risk, why mess around with high spending companies or more complex governments to achieve an extra percent or two? Certain segments of financial markets may find it increasingly difficult to be heard.
