2013: Passive bond investment unlikely to make you rich, says Schroders

A passive approach to fixed income markets is “unlikely to make you rich” in 2013, says Schroders.

Yields on both corporate and government bonds have reached a low point this year, as investors have moved out along the yield curve and credit spectrum in response to falling cash rates.

As a result, investment in bonds often is not even capable of beating inflation, let alone of providing a decent return.

Bob Jolly, head of global macro at Schroders, thinks the coming year will see markets swinging between “euphoria – when either growth or politicians offer positive surprises – and misery – when either the political system takes its collective foot off the reform agenda or we see a temporary ebbing in economic momentum.”

In the coming year, there are a number of global themes on the watch list for Schroders. They include the French economy, inflation concerns in the UK, Chinese fiscal policy and the threat of the fiscal cliff in the US.

Politics will remain a key driver for the bond markets in 2013. Jolly says: “Policy error has the potential to make a bad situation considerably worse.”

Jolly explains that in normal conditions, markets can usually rely on either government spending or central bank easing to come to the rescue if negative domestic or external pressures drive down short term growth expectations.

However, “today, with very little policy room for manoeuvre, the negative impact of, say, an oil price or fiscal policy shock, would be considerably worse than normal due to the lack of policy options available to deal with such a shock.”

“Markets dislike volatility, perhaps more than they dislike bad news itself,” Jolly continues. “Uncertainty over the probability of both the implementation of structural reform and whether governments have the willingness to commit what might be described as political harakiri also drive market volatility.”

The mantra successfully used by the Schroders global multi-sector fixed income team in 2012 has been “fade rather than follow.”

This means that they tend to buy when the market is nervous and sell when it is rallying. Jolly expects the same strategy will work in the coming year, too.

Across the globe, Schroders foresees an ongoing need for balance sheet repair, both in households and governments. This means the global economy will be in a long term period of financial repression.

At the same time, there is a growing risk of a currency battle, “perhaps even war.” The easiest way to boost exports, which Western countries desperately need to do, is to depreciate a country’s currency. This makes its exports more competitive on the global market.

Jolly says Asian countries in particular are likely to feel the pressure to allow a more rapid appreciation of their currencies to help the transition.

Asian countries, especially China, are also expected to introduce measure to boost domestic consumption. This will put further downward pressure on some industrial economies, such as Australia.

The market expectations regarding a likely timeline for a supportive change in monetary policy have changed. Looking into the new year, the return to normality seems to be an increasingly distant possibility, which Schroders has labelled “The Long and Winding Road”, in tribute to the 1970 hit song by The Beatles.

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