Advertorial: Finding yield and managing risk through a global short duration strategy

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Inflation stalking the fixed income sector

Advertorial: Finding yield and managing risk through a global short duration strategy

The search for yield is becoming more and more difficult for investors, as interest rates remain close to historical lows despite growth and inflation picking-up. While the US Federal Reserve is in a tightening cycle, it remains gradual, and the central banks of many other developed countries continue to maintain accommodative monetary policies.

The European Central Bank (ECB) has not yet provided details on its plan for exiting its quantitative easing program, but leaked language on tapering suggests modestly higher interest rates over the next two years as the economic situation continues to improve.

Meanwhile the Bank of England is likely to be cautious on raising interest rates – it needs to balance inflation concerns and growth prospects against an uncertain background of Brexit negotiations. However, should growth and inflation surprise on the upside, there is a risk that major central banks fall behind the curve and need to hike interest rates more aggressively, which could lead to a sharp rise in global bond yields.

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The importance of going global: harnessing yield opportunities and diversification

Investors have only three ways to enhance yields: they can go down in the credit spectrum, look globally for opportunities or extend maturities. Since the latter is not attractive due to historically flat yield curves and the threat of rising yields, investors are increasingly embracing global markets in their hunt for higher returns. Despite declining risk premiums across the board due to central banks’ bond buying schemes, yield opportunities are still available in the global credit market – depending on an investor’s risk appetite and the credit quality of the bonds, the yield pickup can still be quite rewarding.

By investing across the global fixed income market, investors can also benefit from enhanced diversification and therefore reduce portfolio risk. Investors can have access to a wider range of sectors and geographies compared to single markets. For example, the energy market in the US is much larger and more diversified than in Europe or the UK, and therefore offers comparably greater investment opportunities.

To the same extent, the UK’s securitised debt market and Europe’s subordinated debt market are attractive areas that a global investor can benefit from. Another advantage of a global approach can be found in cross currency relative value trading. A key theme in today’s bond market is the rise in issuance of ‘reverse Yankee bonds’ – these are bonds that are issued by US corporates in the Euro-denominated bond market. The ECB’s bond buying programme and accommodative monetary policy has in some cases made it cheaper for US companies to issue bonds in Euros. As a result, investors now have an even greater opportunity to pick one issuer’s bonds in the cheapest currency and benefit from mispricing opportunities.

Volatility is low, but will it last forever?

Global market volatility is currently at a historically low level, but this trend can be misleading. As global growth and inflation gradually rise, bond investors face the threat of higher interest rates. Coupled with this is an environment subject to potential market risks, including a more hawkish approach from central banks and a possible slowdown in China, political risks associated with the Trump Presidency in the US, Brexit in the UK and the upcoming Italian elections in the EU, and geopolitical risks stemming from uncertainty over North Korea and the ongoing crisis in Syria.