Government bond debate: 'functionless' or 'tactical''?
After a broad sell-off in the bond market in May and June, investors disagree over the value of investing in government paper. Higher yields look attractive as a tactical play for some, but others told CNBC that sovereign bonds no longer act as a buffer to risk assets.
Some asset managers argue that bonds are still the most cost-effective stock market diversifier, with selling pressure on government bonds pushing yields higher. However, some investors, such as head of multi-asset allocations at Threadneedle, Toby Nangle, said that government bonds no longer serve as a useful volatility-anchor in portfolios.
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"You usually have government bonds as a buffer in your portfolio against shocks to risk assets, but they just don't perform that function anymore," said Nangle. "They are almost functionless assets in a multi-asset portfolio, so we don't like them on an outright basis, they don't fulfil diversity benefits."
Alan Higgins, chief investment officer at Coutts, agreed that there has been a breakdown in the benefits of holding government bonds.
"Risk-averse investors looking for income have historically also turned to fixed-income markets. But with yields on government bonds having fallen to record lows below the rate of inflation, quality sovereign bonds don't hold the answer to wealth preservation," said Higgins.
Nangle instead preferred Tips (Treasury inflation protected securities), which he said offered high yields, due to mispricing of the "breakeven" rate, or the rate of inflation discounted by markets.
"Breakevens have collapsed and that is basically pricing a policy error," said Nangle.
"One of our most recent moves was buying 30-year Tips. We have put that into the portfolio because of its big positive yields compared to where there were a few years ago."
However, the recent rise in sovereigns debt yields, particularly for U.S Treasurys, could offer a good buying opportunity, according to Percival Stanion, the head of the global multi-asset group at Barings.
"The recent rise in U.S. Treasury yields offers a potential short-term tactical opportunity in fixed income and our holdings in this area are likely to increase soon. U.S. government bonds are also viewed as a modest insurance policy on the Federal Reserve being overly optimistic about growth in the U.S. economy," Stanion told CNBC.
Stanion has also reallocated to Australian government bonds, as a hedge against poorer Chinese growth.
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Edward Smith, global strategist at wealth manager Canaccord Genuity, is also a fan of government debt, and maintained his stance that bonds remain a good diversifer.
"The bigger picture here is that bonds remain a good diversifier in periods of equity stress, and particularly when that stress is not being driven by inflation shocks or unanticipated interest rate hikes," Smith said.
"Bonds may continue to provide a portfolio "bleed", but they are likely to remain the most cost-effective equity diversifier," he added.
—By CNBC's Jenny Cosgrave: Follow her on Twitter