But in recent years it can also be defined as the dog that hasn’t barked. And then, in classic financial market style, just when “it’s different this time” starts to be muttered, here it comes! Or does it?
Predicting what’s going to happen to inflation in the future is not as simple as it sounds. While it is difficult to call whether we are about to enter a period of sustained rising inflation, and therefore what interest rates will do, I suspect things will probably settle down when looking forward a few years – aside from a one-off jump in prices thanks to bouncing commodities and Brexit.
This means interest rates are likely to stay range-bound, and also means interest on cash in the bank is likely to remain paltry. Given that the direction of interest rates is one of the driving factors of the performance of fixed income assets, our recent bond manager review highlighted a few ideas with regards to generating income within the debt space.
Emerging market managers are looking smugly at their opportunity set, while more traditional cash bond funds are scrabbling to find anything worth crunching the numbers on. Trying to find assets to do the job that bonds have done traditionally – be uncorrelated to equities and provide a yield – has never been harder.
For example, Ken Leech, who runs the Legg Mason’s Macro Opportunities fund, is taking advantage of the uncertain rate outlook to play currency and yield curve anomalies. We see this as attractive at present, but investors need income.
Therefore, we continue to look to areas such as mortgage-backed securities to provide this, alongside more total return ideas. ‘Seasoned’ mortgages that were issued before the financial crisis can be accessed through the Angel Oak Multi-Strategy Income fund.
In the US there is no recourse for handing back the keys and defaulting on the mortgage, but these homeowners honoured their payments throughout and are now 10 years into their repayment plans. Asset lease financing is also an attractive area for us, as well as speciality lending in the infrastructure space. In these areas there is a significant element of floating rate exposure, as well as hard assets sitting behind the lending and very attractive yields.
The downside is perhaps more volatility as the market grapples with the complexities of the products’ structure. These products often come in closed-ended form due to the illiquidity of the underlying assets.
Banks have been lending in this space since the dawn of time, but stricter regulations mean they have had to scale back. It means you are left with those who need to borrow and businesses who know how to structure lending, with the missing link being the cash pool in the middle – this is where the vehicles that we look at come in.
Our recent review of the fixed income sector reminded us that nothing remains static in markets. Where there are attractive returns, investors – and banks – will find a way to get involved.
But for now, with returns in more traditional areas so muted, investors need to diversify and look beyond traditional assets if they want to find opportunities that could deliver promising income.
Rob Burdett is co-head of multi-manager at BMO Global Asset Management
