A key consideration for many investors when they buy bonds, particularly government bonds, is the role those assets can play in diversifying from equities.
That diversification benefit is determined to a large extent by present valuations.
Schroders fixed income investor James Ringer says bond markets are no longer pricing in a “hard landing” for the global economy, and instead he says valuations presently reflect “a 50 per cent chance that there is a soft landing for the global economy, and a 50 per cent chance that there is a ‘no landing’ (no real slowdown in growth) for the global economy”.
If the bond market is rather optimistic in its expectations of the global economy, Darius McDermott, investment adviser to the VT Chelsea range of multi-manager funds, says he is not sure that as a good thing.
An area of the market that we believe to be interesting is Brazilian government bonds.Eren Osman, Arbuthnot LathamHis view is that credit spreads – that is, the extra yield an investor gets for buying riskier bonds, such as corporate debt – are not attractive right now.
With that in mind, he is focusing the corporate bond exposure in those funds on managers that specialise in selecting individual bonds, rather than who try to have a broad exposure to the whole market.
In contrast, his exposure to government bonds is mostly held in passive instruments.
For Pimco economist Nicola Mai the curiosity of bond markets right now is that the more risky the bond, the less value is on offer.
He says: “Valuations actually appear more expensive in the higher-risk segments of the market, so investors do not have to give up too much yield to shift exposure into better-quality, more resilient, more liquid areas. For example, our income strategy – we have shifted out of lower-rated and more economically sensitive corporate credit over the last year, and into higher-quality, liquid securitised markets that could potentially provide resilience and price appreciation in a range of economic scenarios.”
But he says that he does feel there is value to be had in lower-risk bonds, as while they yield less, as inflation falls, so the spending power of that income increases, with Mai commenting: “Investors can lock in yields for longer, benefit from rate cuts that will eventually occur alongside the slowdown in inflation and potentially get a much higher return than they can get from cash today.”
Abdelak Adjriou, manager of FP Carmignac Global Bond Fund, is focused more on finding value by taking credit risk rather than duration risk in the current climate, as he says there is less value in the latter due to the influence unpredictable central bank policies have on bond markets.
Credit where its due?
Eren Osman, managing director of the wealth business at Arbuthnot Latham, takes rather the opposite view, cautioning that investors risk being underweight duration as they focus on taking credit risk.
He says: “We would still very much encourage investors to ensure that they have sufficient duration exposure in portfolios. Accepting bonds rallied into the end of last year, as central banks begin to cut rates later this year bond yields should move lower. This means owning more government bonds in general, or potentially buying bonds with longer maturities, which have increased sensitivity to the change in interest rates.
"Finding value in credit is a little more challenging; investment-grade bonds are expensive and the high-yield market in general is even more richly priced.
"An area of the market that we believe to be interesting is Brazilian government bonds; local inflation fell significantly last year and investors are able to achieve one of the highest real yields available in the market at around 6 per cent. Expectations of interest rate cuts by the central bank and stability in the local currency provide further support to the position.”
Jupiter’s head of fixed income Matthew Morgan takes the view that while there are likely to be opportunities for investors seeking higher returns by taking on additional credit risk, the key to returns there may be to avoid the companies that, even if they can pay the coupon on their borrowing now, may not be able to when they have to refinance the debt in the coming years, as the new interest rate will be higher.
Rathbones fixed income fund manager Stuart Chilvers says he sees plenty of value in government bonds. He says yields have reached a level whereby even if there were to be a sell off, for example because inflation proves to be more persistent than is currently expected, then the level of income an investor can collect compensates for some capital losses resulting from a price fall.
St James's Place head of fixed income Frédéric Taché says there is value in emerging market bonds.
Many of those economies have already begun to cut interest rates, which may mean the economies in question grow more quickly than those in developed markets that have yet to cut rates.
From an investor's perspective, the fact that the trajectory and timing of rate movements is already established in many emerging markets means the duration risk question is less relevant.
And if the US does cut rates, the normal expectation is that this would lead to relative weakness for the dollar as a currency, which usually boosts the returns for emerging market assets as those are higher risk, while the dollar is often viewed as a safe-haven asset,
So lower returns from dollar-denominated assets typically leads investors to risker assets.
Taché says the idiosyncratic nature of those markets means one needs to use a specialist bond fund to access them, rather than a generalist or passive instrument.
David Thorpe is investment editor of FTAdviser
