In a new white paper, Low Yields and rising rates concerns: the implications for bond market investors, Vanguard said that investors who are concerned over the possibility of a bond market bubble should remember it is a scenario that differs to a down equity market.
“Bond markets operate differently to equity markets and this paper confirms that in reality a bond market bubble in the same context as we might define an equity market bubble, is not possible,” Vanguard Asia-Pacific chief investment officer Greg Davis said.
“By splitting the performance of a bond into income and price, we can distinguish that over the longer term, income will have the greatest impact on returns regardless of interest rate fluctuations.”
Vanguard has said that with the transparency of central banks and inflation target policies, it is unlikely that there would be an unexpected interest rate adjustment large enough to trigger the bursting of a bond bubble.
However, the white paper said that even if there was a spike in inflation, it would result in a short-term negative return giving way to longer term positivity, due to the nature of bonds.
Furthermore, Vanguard said long-term investors can take advantage of the “pull to par” effect where the market price of a bond converges to par value as the bond moves to maturity.
“The key considerations for any prospective bond investors are related to their motivation for investing in bonds – if you are investing in bonds for their income or diversification properties, then you should not be concerned about changes in interest rates,” Mr Davis said.
“However, if you are investing in bonds because of past high performance, then you need to be realistic in your expectations – the next 10 years are unlikely to look like the past 10 years.”
