Company pensions are mainly invested in Govt Bonds believing they are safe. Many commentators are suggesting as I said a few weeks ago, Bonds are a potential bubble.

Look at these comments in today’s FT.

Savers who have stocked up on bonds with record low yields face danger on two fronts: on the one hand, their income could be eroded by inflation, while on the other, the value of their holdings could fall sharply when interest rates do start to rise.

“Investors are still worried by the volatility roller coaster they see in the equity market,” says Andrew Lo, professor at the Massachusetts Institute of Technology. “Investors, and in particular retirees, feel they have little choice but to go into bonds.”

Consider $1m invested in 10-year Treasuries. The asset manager MFS calculates that if bond yields rise from 1.75 per cent to their long term average of 5 per cent by the end of 2017, adjusted for inflation the investment will be worth just $690,000 in today’s money, a real loss of about 7 per cent a year.

The rise in rates may not be slow and steady, though. As the economy improves, producing stronger growth and rising inflation, the Fed is likely to wait before tightening monetary policy so as not to damage the recovery. But the bond market will quickly price in the risk of higher rates, led by a jump in long dated yields. For investors holding bonds with a long maturity at a low fixed rate of return, such a scenario would strike hard.

“When interest rates are near zero, it should loom much larger in your perception of risk than it does for most investors,” says Mr Steinmetz. He does not expect the Fed to raise interest rates before 2014, or 2015, but cautions that signs of healthy economic growth could prompt rates to move in anticipation.

“Market participants will immediately start talking about the Fed being behind the curve.”

“We spend a lot of time worrying about the bond unwind,” says Michael Kastner, managing principal at Halyard Asset Management. “A lot of money has piled into the sector and will go in the opposite direction at some stage, they are clearly in bubble territory. Everyone in bonds has the same idea that they can get out before others when the market turns.”

There is no question in my mind that Bonds will fall, the only question is when. Can pension funds predict the time? I’d suggest not. Pension funds are already in deficits  when the fall in Bonds comes it will only make a bad situation worse.

Nigel Green deVere Group

Blog written 19th of November