Taper time: eight DFMs reveal their top bond calls
Investment analyst, Cumberland Place Financial Management, London
‘With inflation now manifesting in most developed markets, it is starting to feel that we will be entering a global rate rise environment very soon. This setting does not classically make for a fertile hunting ground in fixed income and so we favour short duration assets as a theme.
‘Such products tend to enjoy low interest rate sensitivity while still producing an attractive return. Shorter duration bonds also tend to exhibit lower default rates as opposed to longer-dated bonds, which help to preserve capital and minimise volatility. Such investments also yield considerably more than cash on deposit, helping them to become almost ‘cash proxies’ within a portfolio.’
Chief investment officer, Patronus Partners, London
‘Historically, the two main roles that bonds have played in investors’ portfolios have been to provide income and diversify equity risk. Their ability to do this going forward, due to current pricing, is severely impaired. Investment in long duration fixed income at current yields has become more about price speculation, based upon the trajectory of the growth and inflation outlook.
‘For those looking for stability with inflation protection, index linked gilts are the obvious choice but with real yields currently around -1.5% for 20-year index linked gilts, they condemn investors to guaranteed real losses over their term. Real yields on treasury inflation-protected securities (Tips) in the US are still positive, with the 20 Tips yielding around +0.5%. UK investors can buy these bonds with the currency hedged via a London-listed ETF. However, they should be aware that they are indexed to US, not UK inflation.’
Chief investment officer, Hywin Wealth, London
‘One of the best opportunities within fixed income is the US high-yield market because it offers very attractive returns (approximately 6%) with contained duration risk.
‘We focus on commodity related companies, mainly within the energy and precious metals sectors, given their improved credit conditions.
‘The removal of near-term refinancing pressures through large dividend cuts, and substantial capex and opex reductions have enhanced these companies’ cash positions, and in turn spreads have narrowed.
‘On the other hand, we do not believe European high yields are compelling investments on a risk-adjusted basis. The excess liquidity generated by the ECB’s QE programme has kept yields artificially low in the sub-investment grade sector, underestimating the credit risk of most of these entities. Despite the rally and spread compression, we favour EM corporates both in hard and local currency as they still offer and interesting return profile (above 4%) in an improving macro environment.’
Investment director, Octopus Investments, London
‘Emerging market debt is an area we are looking to add to within our fixed income portfolios at the moment. This may come as a surprise to some considering the strong rally the asset class has seen so far this year.
‘There are a number of reasons for our more favourable view of this particular part of the bond market. Firstly, growth is accelerating in many emerging markets and central-bank policies there have improved current account balances in the region. Secondly, inflation is stubbornly refusing to take hold across the globe so despite the recent rally in emerging market debt prices, real yields within emerging markets are more attractive relative to those in the developed world.
‘Finally, we believe emerging market sovereign debt offers our bond portfolios diversification benefits, in terms of the default risk cycle exposure relative to that of corporate bonds, which we also hold.’
Director and co-head of fixed income, Waverton Investment Management, London
‘The best opportunity in bond markets today is negative duration.
‘The world has become used to low interest rates, accommodative central bank policy and the absence of any kind of inflation threat. Investors have a tendency to be backwards looking and project recent experience far into the future, but if we examine the prospects for the global economy today we see all the major economies showing decent growth. The oil price is heading back up to its highs for this year and central banks are lining up to reverse the policies they have been following since the financial crisis.
‘Meanwhile, most bond markets still trade at exceptionally low yields, giving no compensation for inflation risk. Indeed, in Europe there are still 12 countries offering negative yields for government bonds over the next five years. Investors are not prepared for any kind of normalisation of bond yields. Beware of duration risk in all bonds.’
Head of investment research, Carrington Investments, London
‘Bond markets are under the spotlight given the collectively hawkish stance from major central banks around the world. Due to valuations and changing fundamentals, we have been nervous about a number of areas and have sought to gain exposure in the less commonly held bond markets.
‘Asset backed securities, specifically collateralised loan obligations (CLOs), have offered excellent diversification benefits. Issuance has been strong this year with the asset class continuing to provide good relative value when compared with corporate credit and high yield. Importantly, CLOs are typically floating rate providing a hedge against what is likely to be a rising rate backdrop.
‘Due to these qualities and the improving macroeconomic environment, we believe this area of the bond markets will outperform over the next 12 months.’
David Amphlett Lewis
Co-manager of managed portfolio service, Smith & Williamson, London
‘The temperament of my favourite bond managers tends to vary between mild pessimism and outright dread because a principle rationale for holding bonds is the price stability, secure income, and liquidity they can provide when other asset prices are falling.
‘Current low yields in the UK make bond prices particularly sensitive and fierce competition between investors for income means caution is warranted. Investors concerned by Mark Carney’s suggestion that UK interest rates may rise usually turn to funds in the Investment Association’s (IA) Strategic Bond sector, where managers have wide scope for the use of derivatives and currency positions, and which has over five years underperformed the older IA UK Corporate Bond sector.
‘We prefer managers who tilt their strategies more modestly in response to the movements in Gilts, and focus more on bottom-up credit selection. In contrast to the equity fund universe, the actively-managed bond fund sector has offered better risk-adjusted returns than comparable ETFs in recent times, and good managers should be able to protect capital value without spending too much of our clients’ hard-earned secure income on derivatives.’
Head of fixed income, Sarasin & Partners, London
‘The next few quarters could be particularly challenging, with tactical skill determining bond manager performance. Simultaneous global growth has now returned –presaging the end of the ‘Goldilocks economy’, the era of ‘free money’ and central bank efforts to inflate bond prices. However, many of the secular forces that have supported bonds since the bull market began in 1982 (independent central banks, inflation targeting and demographic trends) will not change.
‘These forces are likely to manifest themselves in secular lethargy – replacing the secular stagnation of the post financial crisis decade. Markets may reprise somewhat as central banks start to cut them loose – bond yields will float up to their natural levels.
But historically, markets have tended to overshoot. A temporary "buyers strike" is a distinct possibility – and this could provide an attractive buying opportunity for the nimble. Good defence and good offense may be required in quick succession.’