The British asset manager, which oversees approximately £1.2 trillion, has been purchasing sovereign debt while taking offsetting positions in bond futures, according to Chris Jeffery, its head of macro strategy. The approach reflects growing concern that government borrowing pressures and persistent inflation could push yields higher still.
The strategy allows the firm to retain exposure to bonds it considers attractive without accepting the full risk of another abrupt decline in their prices. Bond prices move inversely to yields, meaning investors buying after a sharp selloff can face further losses if borrowing costs continue climbing.
Jeffery identified the United States as a particular source of concern. Strong economic activity, large fiscal deficits and the additional financing demands associated with artificial intelligence investment have complicated expectations for interest rates and government debt supply.
A rising term premium, the extra compensation investors demand for holding longer dated bonds rather than repeatedly investing in short term securities, has added to the pressure. The premium reflects uncertainty about future inflation, interest rates and the volume of debt governments will need to issue.
The manager’s defensive positioning is significant because it has previously used episodes of bond market weakness to increase holdings. Its latest approach combines selective purchases with protection against adverse market moves rather than making an unhedged bet that yields have peaked.
Futures contracts can gain value when the price of the underlying bonds falls, offsetting some losses on cash holdings. The protection is not costless or exact: movements in futures and the bonds being held can differ, while changes in market conditions can affect the effectiveness of a hedge.
Global sovereign debt has endured renewed pressure as investors reassess the outlook for inflation and monetary policy. Higher energy prices, government financing requirements and uncertainty over the direction of central bank rates have all contributed to volatility across major markets.
US Treasury yields climbed to levels not seen for more than two decades before retreating this week. The move has attracted buyers seeking income but also raised questions about how much further bond prices could fall if inflation proves difficult to contain.
The International Monetary Fund warned in its latest Global Financial Stability Report that rising sovereign yields and stretched financial market valuations could amplify instability. Its assessment also identified risks linked to an abrupt reassessment of investment expectations surrounding artificial intelligence.
The tension is particularly evident in longer maturity bonds. These instruments offer investors the opportunity to secure comparatively high yields for extended periods, but their prices are more sensitive to changes in interest rate expectations than those of shorter dated securities.
Britain’s gilt market has faced similar pressures, with benchmark yields reaching levels associated with the period before the global financial crisis. Japan has also experienced pronounced increases in borrowing costs as monetary policy normalisation changes demand for domestic government debt.
France has emerged as another focus of concern, reflecting political uncertainty and pressure on public finances. European Central Bank President Christine Lagarde said on Wednesday that the country must address its fiscal difficulties through domestic policy, rather than assuming the central bank would intervene.
Other large investors are nevertheless returning to government bonds as yields improve prospective returns. The higher income available on sovereign securities has renewed interest in fixed income allocations, even among managers wary of further short term price fluctuations.
Jeffery’s approach highlights the distinction between finding bonds attractive at prevailing yields and expecting an immediate recovery in their market value. An investor can favour the income offered by government securities while protecting against another increase in yields.
Political developments could also influence the timing of any reduction in hedges. The US midterm elections on 3 November may provide additional information about the direction of fiscal policy, although the subsequent outlook for debt issuance and interest rates will remain dependent on economic data.
Legal & General’s asset management operation serves pension schemes and other institutional investors for whom government bonds play a central role in matching long term liabilities. Its broader group also operates substantial retirement and insurance businesses, making interest rate movements an important consideration across its activities and the management of its investment portfolios worldwide.
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