Martin Reeves, head of global high yield, Legal & General Investment Management
Since Ben Bernanke’s comments on the tapering of Federal Reserve asset purchases, sterling corporate bonds have fallen around 4.5 per cent. Global high yield bonds – although slightly down since May – have earned a positive return year-to-date, benefitting from the sector’s equity-like characteristics and structurally lower interest rate sensitivity.
Rising interest rates are bad for bonds but higher rates are usually a reaction to stronger economic growth. Under this scenario, high yield (and investment grade) bonds can perform well as economic growth drives corporate earnings and the ability of companies to repay their debt improves.
However, because of their greater credit risk, high yield bonds offer higher coupons and tend to have shorter maturities than investment grade bonds. This means that high yield has a lower duration than investment grade and high yield bond prices are therefore less sensitive to rising interest rates.
Although the case for high yield is attractive, performance across sectors and countries/regions is likely to vary enormously. So it makes sense to focus on regions where growth appears strongest and bonds have the greatest chance of being upgraded.
Today, that means seeking out exposure to the consumer-led recoveries in developed economies, but doing so selectively. For example, some higher quality US high yield bonds are relatively exposed to interest rate risk so better opportunities can be found in the euro zone and the UK.
Twelve months ago it was hard to invest in parts of Europe with great conviction and emerging markets seemed much better value. Now we see a reversal of fortunes: eurozone risks appear to have eased and growth has bottomed out, while emerging markets are suffering from slowing growth. Like always, though, it is likely to be a temporary shift so fixed income investors will need to continue adapting to a changing landscape.
Ian Winship, manager, BlackRock’s Absolute Return Bond fund
The main driver for global bond markets will be monetary policy. However, volatility of returns across markets will remain as policies are starting to diverge.
The US Federal Reserve is the first major central bank to start winding down its massive stimulus, trying to pave the way for a gentle exit from quantitative easing. The Federal Open Market Committee would like to begin the tapering process because even if recovery is not robust the economy is better than it has been in several quarters. The unwind process will begin in September.
Elsewhere in the UK, Europe and Japan we would expect central bankers will continue to adopt more dovish rhetoric in order to keep interest rates low. However, considering the positive economic data releases across the US, UK and Europe recently, we think interest rates could drift slowly higher.
The market will remain preoccupied with central bank policy announcements and key data releases. In this environment, we believe our portfolio would benefit from more tactical trading to exploit short-term market dislocations.
From a bottom-up point of view, we believe that fundamentally, corporate and financial institution balance sheets are very healthy, the high yield default rate is at historic low and on that basis we are looking to add credit risk to the portfolio in the coming months.
Emerging market assets remain weak and we do not expect them to recover to their highs reached earlier this year any time soon. Liquidity is likely to remain challenging and outflows from this asset class have not showed signs of stopping. We maintain that relative value opportunities exist for active managers.
Nick Hayes, manager, Axa WF Global Strategic Bonds fund
Bond markets are seemingly at a crucial turning point, after years of extraordinary loose monetary policy since the financial crises of 2008. The well documented weak global economic recovery has meant that ultra-low interest rates have been supported by various rounds of quantitative easing and more recently ‘forward guidance’ in order to keep bond yields low. Bond markets, along with other main stream asset classes, have benefited but economic growth has been slow to react.
We are finally starting to see signs of a recovery, led by the US, and speculation of less monetary stimulus has led to a reversal in Government bonds, and also certain other credit sensitive parts of the global bond market.
More than ever the ability to invest globally is important. And by global, I mean geographically, and also global in the sense of different types of bond markets.
So with a strengthening US economy, an improving but still fragile European economy and a weakening emerging market outlook I am positioning the fund accordingly. Our exposure to US based assets are predominantly very credit sensitive, with a high exposure to high yield which will benefit from a stronger economy and is less sensitive to a US treasury sell off.
We also have exposure to US inflation linked Treasuries which should benefit from higher inflation expectations.
In Europe, while we also like exposure to high yield, we have more exposure to investment grade and some government bonds that will benefit from continued loose monetary policy and a weak economy.
Finally in emerging markets we have a more cautious stance given the uncertainty around weakening economies and potential continued asset flows, which are currently affecting local currency and FX markets.
Recent bond market returns have proved strong and, while some of these will not be repeated, there are certainly still plenty of opportunities to own attractive yielding bonds, in a recovering global economy.