Fantastic yields and where to find them

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Investing in ETFs and trackers

Fantastic yields and where to find them
 Performance of US and European bonds in the past year

Perhaps ‘fantastic’ is a bit of a stretch, but that does not mean that decent yields cannot be found if you know where to look for them.

Ten years on from the start of the financial crisis and fixed income investors are being selective with their allocations. 

The reaction of the major developed market central banks to the crisis was initially to slash interest rates towards zero before moving into unconventional policy easing. 

The consequence of these unprecedented actions has been for yields in developed markets to hit all-time lows. 

By design, quantitative easing (QE) is aimed at forcing investors to take on more risk, whether that is by switching from the relative safety of government bonds to investment-grade and even high-yield corporate debt, or through revising overall portfolio asset allocation by moving from lower volatility fixed income products to higher volatility equities and alternative asset classes.

What next? While it has been a long road to recovery and growth has not rebounded as quickly as it has following previous recessions, the global economy no longer appears to need such emergency policy. 

Indeed, in the US the Federal Reserve has already started a very gradual tightening of monetary policy and is now looking to start reducing the size of its balance sheet. 

In the eurozone, with inflation picking up, it seems likely that the European Central Bank (ECB) will also look to ease back on the pace of QE, even if it is not yet ready to move into a tightening cycle.

One point that is worth noting, however, is that the great recession was mainly a developed market phenomenon, and while many emerging economies also moved to looser monetary policy to spur a recovery, they did not have to go to the extreme policy measure seen in the G7.

With this in mind, it is interesting to note that while low rates in developed markets may have held back some demand for fixed income, there are still areas that can aid investors to achieve their goals. In particular, as central banks in developed markets look to withdraw some policy accommodation, investors appear to be preferring low-duration benchmarks or are alternatively switching their focus to emerging market debt and the high-yield bond market. 

Indeed, based on Morningstar data for the European ETF market, so far this year emerging markets have seen very strong demand, whether it is local or hard currency bonds. 

Here, investors not only benefit from a significant yield pick-up relative to developed market sovereigns, but in addition, should the global economy take a turn for the worse, there is room for these central banks to cut rates.

There has also been strong demand for the US investment-grade corporate bond market, although a large part of this allocation has focused on defensive floating rate notes, which will not suffer the same degree of capital loss should yields rise.