Zeroing in

Deflationary pressures are a powerful thing. At 1.85 per cent, the ten-year US Treasury yield is now roughly where it was prior to the surprise election of a fiscally stimulative president. It’s also well below the 2.3 per cent level at which the Federal Reserve first began hiking rates in late 2015.

Yet resistance to the idea of falling bond yields is still deeply ingrained among investors. So eyebrows will have been raised at a recent JPMorgan analyst note, asking what might happen if the US ultimately joins Europe and Japan in a zero-yield world.

Unsurprisingly, the analysts state that 10-year yields dropping to 0 per cent is not their base case. But they caution it is a scenario “that bears considering and hedging”. A prolonged trade war could yet result in rates returning to zero, QE restarting and political gridlock over the need for further fiscal stimulus, according to the JPM long-term strategy team.

And it’s the implications of such a fall that prove most intriguing. The analysts say they find “no evidence in equity and credit markets of abnormally high asset prices, as credit spreads and equity yields do not fall below their historic means when bond yields are driven down to zero”.

In short, a collapse in government bond yields would not prompt a rotation away from bonds into equities. That’s clear from European and Japanese investors’ experience - and a similar trend can even be seen in our own analysis of how wealth managers have responded to the recent surge in sovereign debt prices.

Still, the JPM analysts do back dividend-yielding stocks as one place to be, in part because their existing qualities would not be eroded by a shift to zero yields. On EM equities, typically a beneficiary at a time of a falling dollar, it’s a different story: deflationary forces such as low productivity growth and a low demand for capital are unlikely to mean they're viewed with much favour. 

The exception is one part of the investment universe that fund selectors have historically been reticent to back materially: emerging market debt. JPM thinks a race for yield would indeed take place in this asset class, driving major inflows. That really would be a sea-change moment for investors of all stripes.

A strategic surge

When it comes to comebacks, the return to favour of UK equity funds has been particularly shortlived. Having briefly returned to positive sales territory in May, they were back in the red the following month. But Investment Association data shows that, with central bank policy back under the spotlight, a different kind of offering is very much back in vogue.

Strategic bond funds were the best-selling cohort of the month, racking up a net £1.1bn in retail sales. That’s the highest amount taken by any sector since November 2017, when go-anywhere bond funds again topped the charts. Appetite for these strategies, when it emerges, is voracious: the sector is the only IA grouping to have ever taken in more than £1bn in a single month, and it's now done so on four separate occasions.

An obvious catalyst is investors reassessing bond funds as monetary policy turns: fixed income was the best-selling asset class for a fourth consecutive month this June, taking a net £2.4bn of sales. The Sterling Corporate Bond sector alone took in £453m.

And the current situation is one in which strategic bond offerings are particularly well placed to thrive: as we’ve noted before, the positioning of DFMs' top picks here shows that the group can cater to both bearish and bullish dispositions on the asset class.

Overall it was another positive month for sales: UK retail investors put a net £2.3bn into funds, making June the third consecutive month of inflows.

DFMs themselves were less bearish than before, albeit still more cautious than most. In June they were responsible for £30m of net outflows. That’s significantly down from May’s £259m in withdrawals, but downbeat compared with the behaviour of other intermediaries, who put a net £1.9bn into funds over June.

Beta beaters

We wrote earlier this week about the persistence of certain investment factors as a way of judging top-performing companies - and noted the question for investors, as ever, is how exactly to implement that data in a way that works for portfolios. 

Nowadays, any mention of ‘factors’ naturally lends itself to thoughts about smart beta. But while flows into such products are continuing to accelerate in Europe - the first half of 2019 broke the H1 2017 record for inflows, according to data from Morningstar - outcomes aren’t always so bright. 

Analysis from Research Affiliates has found that most funds categorised as smart beta have underperformed broader indices over the past decade. That’s an obvious consequence of the investment styles that they tend to favour, value stocks being the obvious example. But either way, it’s clear there’s still a gap between theory and reality for many such products.