For bond investors, the Brexit vote was simply one more factor pushing down interest rates – finding a good yield remains the priority.
It has been an unprecedented few years on credit markets. On the risk side, balance sheets have been subject to increased scrutiny and regulation, leading to healthier debt profiles across developed credit markets. Meanwhile, central banks have become credit markets’ most important buyers, pushing down yields with both rate cuts and enormous programmes of quantitative easing.
In recent months, yields have fallen still further, a number of central banks have pushed interest rates to record lows, and global growth, while not spectacular, has continued at a gradual rate. In short, it has been a good environment for credit.
“Brexit has been the recent driver on markets, which has presented opportunities as risk was taken from equity markets and there was a rally for bonds,” says Raffaello Distefano of Loomis Sayles. “Meanwhile, global growth remains muted but steady. This provides an ideal environment for corporate bonds – for picking up extra yield. Moreover, the bond cycle has been extended, as the Fed has held back the next rate rise.”
Of course, there may be more shock events to come in the autumn – referenda in Hungary and Italy, and presidential elections in the US, carry significant political risk that could be felt in credit, should the results go against market preferences or expectations. Nevertheless, David Riley of Bluebay Asset Management believes that the hunt for yield will be more important, and views the current environment as positive for credit.
“The search for yield is likely to continue, but the possibility of further bouts of volatility should not be ignored,” he says. “An environment of lower-for-longer interest rates and positive, albeit mediocre, global economic growth and corporate earnings is favourable for positive-yielding assets, notably credit and emerging market debt. Our focus [has] a bias for higher-yielding assets.”
Given the downward pressure exerted on yields in recent months, often at the hand of central banks, that focus is understandable; over the summer, a couple of major benchmark yields have fallen to record lows. But if high-yielding assets are somewhat scarcer in credit markets, they are far from absent – and much depends on where you are looking.
“Rate cuts and asset purchases have sucked the yield out of markets,” said Mark Holman of TwentyFour Asset Management. “But the US is trying to go the other way. Yield is going to be increasingly difficult to find, but the US is different – around 70% of the yield in world markets is in the US market, and so lots of people are trying to buy US assets.
“There are plenty of opportunities at the moment in UK and European high yield, as they’re still quite cheap,” says Holman. “But you’ve also got to look at the US. In fact, [while] 4% of the world’s bonds by volume are in US high yield, [the sector has] 23% of the world’s yield, so it’s worth having a look – not all the bonds are metals and miners.”
Nevertheless, those US opportunities may be narrowing. Bluebay’s Riley believes that dollar assets – whether in the form of US Treasuries, credit or emerging market debt – have been the principal beneficiaries of capital leaving Europe and Japan in the wake of central banks in Tokyo and Brussels pushing interest rates negative.
“Our bias is to take profit in global high yield and gradually rotate exposure into emerging markets over the coming quarter,” says Riley.
If there are geographical inconsistencies in credit markets worth tapping into, there may be pricing discrepancies between sectors that managers can leverage too. Loomis Sayles’s Raffaello Distefano and TwentyFour’s Mark Holman are both overweight in financial companies.
“We have a good weighting in financials,” says Holman. “They are better-capitalised today than I’ve ever seen them before, so I’m even happy to buy subordinated [i.e. higher-risk] bonds, where there’s plenty of yield.”
He is also confident that, despite recent yield declines across credit markets, there are ample opportunities for investors.
“The fixed income world is $50 trillion in size – there are still plenty of places to look around.”
Loomis Sayles, Bluebay Asset Management and TwentyFour Asset Management are fund managers for St. James’s Place.
The opinions expressed are those of Raffaello Distefano of Loomis Sayles, David Riley of BlueBay Asset Management, and Mark Holman of TwentyFour Asset Management and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. Full advice should be taken to evaluate the risks, consequences and suitability of any prospective fund or investment. The views are not necessarily shared by St. James’s Place Wealth Management.
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