Opportunity remains in fixed income, says Dexia’s Van Weyenberg
Despite tapering fears there are still opportunities in bonds, says Ken Van Weyenberg, investment specialist at Dexia Asset Management.
Any “tapering” of US quantitative easing will probably happen gradually, while the global policy will remain accommodative. Furthermore, the Fed is being cautious about communicating on the subject in order to keep rate rises under control.
However, these developments have shone a spotlight on the debt markets and have prompted a number of investors to look at their bond portfolios and the wider market in search of complementary opportunities.
Looking exclusively at government bonds, it is clear there are long-term gains to be made, particularly in European peripheral bonds. The outlook published by the European Central Bank gave a boost to the market, as it is expected to keep rates low for a sustained period. This should further support peripheral countries’ debt in a short term horizon.
Spanish bonds represent an even greater opportunity. The main point in Spain’s favour over peripheral countries is that the country has limped out of recession in Q3, after more than two years in a difficult situation. This has allowed Spanish firms to gain in competitiveness which is a positive catalyst.
Italy, by contrast is fairly neutral, and Portugal is underweight in relation to the refinancing challenges it faces in 2014.
When it comes to corporate bonds, it is clear that the selling pressure on investment grade corporate bonds was slightly exaggerated in June despite the threat of tapering and renewed political risk.
The credit segment has good prospects, both on financials and non-financials. At the European level, subordinated issues within the financial sector are probably more favourable. Overall, players in the sector have maintained efforts to de-risk their portfolios and improve liquidity at the expense of profitability pressures from the regulatory environment. Dexia Asset Management is overweighting non-financial companies as well, as we do not believe the wall of maturities expected in 2014 (€200 bn of redemptions only for IG non-financial companies) will put major pressures on credit spreads. The negative net supply in the current low yield environment, liquidity excesses and lack of alternatives favours the hunt for yield. At the monetary level, possible further support of the ECB (via SME loans securitization) as well as the postponement of the Fed’s tapering are credit supportive.
High-yield bonds also remain attractive. This segment is still being supported by healthy fundamentals and default rates below historical average levels. In addition, there is continued demand for new issues in the primary markets, with investors still seeking returns in the current low-yield environment.
Emerging market bonds, on the other hand, are still somewhat risky. Following the substantial pre-summer correction, emerging market bond markets did stabilise after massive sell-offs. The postponement of the Fed tapering triggered a partial recovery from the lost ground. However, the risk premium on EM bonds is back to attractive levels and net flows have stabilised.
Convertible bonds have also suffered from the tensions in the bond markets in recent months, in spite of their previous outperformance versus other bond segments.
The summer was not the best period for such assets due to falling equity markets, rising interest rates and widening credit spreads. Of course, these last two could lead to a revival of the primary market over the next few months, which, as a result, could provide more attractive valuation levels.
An active primary market could result in further investment opportunities and promote a renaissance of the convertible bond investment universe. As such, convertible bonds will continue to benefit from their exposure to the equity markets. However, over the short term it is worth being cautious with respect to convertible bonds, as they have already been experiencing strong performance since the start of the year.
Ultimately, there are a number of attractive segments but our experience of bonds over the past 10 to 20 years has taught us that actively managing your portfolio and building in proper diversification is essential to achieve the greatest performance.
Investors looking at the opportunities bonds can provide must remain mindful of these principles.