Fixed Income - February 2012

Published by Investment Adviser | Feb 13, 2012

Ultra low interest rates and falling inflation, while generally viewed as negative factors for investors, actually favours fixed income assets in general.

Ultra-low interest rates and falling inflation, while generally viewed as negative factors for investors, actually favours fixed income assets in general.

While AAA-rated government debt markets are more than discounting this scenario, according to Jonathan Platt, head of fixed interest at Royal London Asset Management (Rlam), corporate credit has much less of a valuation issue, remains less volatile than equities and, in recent months, has actually been less volatile than so called ‘risk-free’ sovereign debt.

Looking at the extent of debt in the UK, markets remain fixated on government borrowing and the efforts to cut the deficit. UK financial sector debt has ballooned since 2005, and while this debt has seen a good level of deleveraging there is still a long way to go in tackling this important underlying economic issue. In certain respects the situation resembles the Japanese economic crisis that began 20 years ago and culminated in ultra-loose monetary policy in the country.

JP Morgan’s Strategic Bond fund manager Nick Gartside, says: “We still firmly believe that the ‘road map’ from Japan presents a fantastic environment for fixed income assets now, and acknowledge that Japan is already 10 years ahead of many western economies.”

Credit risk still infected an increasing number of government bond markets in 2011, however, causing the list of investments classified as ‘risk free’ likely to dwindle further.

With real yields in negative territory in core markets, the potential for further gains is limited and the risk of significant loss is magnified.

By contrast, Bryn Jones, fixed income fund manager at Rathbone Unit Trust Management, claims that the level of yields in high yield and investment grade bonds are pricing in levels of default higher than those seen in the Great Depression of the 1930s.

He says: “Too much risk is being priced in. High yield bonds, [those] that might have leveraged balance sheets, have them as this is the optimum capital structure. These businesses are still generating fantastic cashflow and as long as they can fund themselves, they remain attractive investments.”

For investors in high yield, corporate and government bonds, the question is whether fixed income will continue to offer value, or has it had its run?

Jenny Lowe is features editor at Investment Adviser