Multi-asset managers face spectre of low yields and rate rises

Old Mutual Global Investors portfolio manager Anthony Gillham, who specialises in fixed income, says that the Bank of England’s February inflation report was a ‘game-changer’.

As the forward guidance suggested that interest rates may not rise as quickly as investors expect them to in spite of the unemployment rate reaching its target.

Mr Gillham says: “The most interesting thing for me is that interest rates in the medium term are going to be lower than the 5 per cent base rate seen in previous cycles. This implies that gilt yields may not rise to the extent that people expected previously.”

He points out that this means gilts at the level of roughly 3 per cent yield will become more attractive to investors and may result in the team adding to interest rate duration more quickly than they anticipated six to nine months ago. The current yield on a 10-year UK gilt is 2.79 per cent.

In contrast, Aberdeen Asset Management head of global strategy & asset allocation Mike Turner has been reducing the gilt and index-linked gilt exposure in the Aberdeen Multi-Asset fund. He has been doing this over the past few months on the basis that this year the market is going to suffer several bouts of anxiety over interest rates going up.

An area that Mr Turner says looks attractive, but it is not yet time to buy into, is emerging market debt (EMD).

He suggests EMD is attractive at 5-6 per cent yields, with some countries looking interesting on a fundamental basis.

He adds: “Emerging markets have taken a tumble, but we need to see more stability there to invest in EMD, as there is still more volatility to come in terms of fund flows.” Mr Turner is keeping an eye on this, as he suggests the move away from emerging markets is more a bout of nerves, given that many investors are positioned as overweight.

Henderson Global Investors fund manager James de Bunsen has taken the move into EMD for the first time in roughly 18 months across the main multi-manager funds, including the Henderson Income & Growth and Distribution funds.

The team have exposure through an ETF, but are in the process of looking for an active manager. Mr de Bunsen has gone for hard currency bonds, rather than local currency bonds, he explains: “Local currency bonds will give you the best returns over the longer term.

“However, we’re not convinced we have seen the last of the volatility. The currency is driving local currency bond returns and there is potentially some further weakness to come.”

He points out the yields of dollar EMD relative to high yield are attractive, noting: “You get roughly 5.5 per cent on high yield and more than 6 per cent on dollar EMD, which we think is a level at which investors will start looking at EMD again. Six per cent on what is essentially investment grade debt is a decent return.”

Meanwhile, TM Darwin founder David Jane sold his position in emerging market bonds in May, “as the ending of quantitative easing looks set to reduce the amount of money flowing into an overvalued asset class.

“Even following the falls we don’t see sufficient value to get involved yet”.

He also suggests most areas of corporate bonds seem unattractive, given exposure to rising yields and historically narrow spreads over government debt.

He adds: “We still see attraction in peripheral eurozone government bonds where spreads remain high over German yields, but the risk of default is reducing as economic recovery takes hold.”

Joanne Ellul is a freelance journalist