Kames Capital and JP Morgan Asset Management believe bond holders are unwittingly being subjected to this risk after piling into credit from issuers that are seeking to lock in low borrowing costs for longer periods.
The warning comes after bond yields have been pushed to record lows in recent years thanks in large part to central banks’ quantitative easing programmes.
Traditional interest rate-driven bonds have experienced record inflows of more than $320bn (£244bn, €273bn) over the last 12 months.
Interest rise risk
With central banks hinting at potential rate rises in recent weeks, Mark Benbow, fixed income fund manager at Kames, fears a rise in interest rates would create a drop in bond prices.
He added: “One of the biggest concerns that bond investors face right now is duration risk – the risk that a rise in interest rates creates a fall in bond prices.
“Considering that the duration of bond benchmarks has been rising for the past 20 years, investors are wise to be mindful of this risk.”
Benbow said the issue was particularly acute for passive investors who have no control over the issues to which they are exposed.
“Many fixed income portfolio managers are being dragged longer in duration as their underlying benchmark duration has increased, therefore exposing the end investor to additional interest rate risk by default rather than design.”
Greater fool theory
Oksana Aronov, client portfolio manager at JPMAM, said with current ultra-low rates and spreads approaching all time tight levels, bonds have gone through a process of “commoditisation”.
She said: “As the amount of negative yielding debt exceeds $6trn globally, bonds increasingly cease to trade based on fundamentals, such as yield, and trade instead on what someone else might be willing to pay for them in the future.”
To illustrate this point, Aronov observed that a Swiss government bond maturing in 2049 is currently trading at more than $104 above par.
“With premiums of this magnitude, bonds are effectively commodities, and investors are using the greater fool theory as an investing strategy,” she added.
