Understanding strata of fixed income crucial, Geneva Forum delegates told
Fixed income managers told delegates to InvestmentEurope’s Fund Selector Forum in Geneva recently how analysis of fixed income and the macro climate is key.
Fixed income managers at InvestmentEurope’s recent fund selector forum in Geneva emphasised the need for differentiated analysis of various strata within their asset class to make money and avoid losing it.
Investors should consider emerging markets debt, but not quite yet “because valuations look stretched especially in investment grade”, said HSBC Global Asset Management’s Nathan Chaudoin.
Chaudoin’s team favours central and eastern European sovereign paper of Romania, Lithuania and Poland, for example, which has been too harshly sold on fears of eurozone links. For corporate bonds, the team still prefers Latin America.
When spreads widen, Latin America will “sell off first because it is over-owned”, so CEE exposure will offer defensive characteristics.
Ahead of the crowd
Chaudoin said it is crucial to move before the crowd follows, because liquidity is “so poor you cannot afford to wait because there is no liquidity to buy once things start to rally or to sell when things start falling”.
EM currencies, he said, sit roughly at fair value, but at the investor level holders have swung between all-time high long US dollar/short EM currencies at the start of the year, to the opposite stance as central banks provided stimulus and a ‘risk-on’ climate.
Morgan Stanley European head of fixed income Richard Ford told the forum it was important strategies take advantage of regulatory and policy developments. This may involve taking advantage of corporates where governmental SME refinancing schemes are in place, or financials where central support targets banks.
Diversification is also key. “I think yields will go up, but it is still sensible to own a small holding of 30-year government bonds, to reduce the volatility of an overall portfolio,” Ford said. His team’s highest conviction at present is US non-agency mortgages – primarily residential – followed by high yield, financials and EMD.
Various policy measures have affected each of these in turn.
Ford said yields in Bunds were so low as to make the investment risk asymmetric, whereas in credit “spreads look attractive relative to the risk-free asset, but absolute yields are still low. The beta of fixed income moving to low yield has been a win-win strategy, but the past may not be a guide to the future.
Ford counselled keeping an eye on four key macroeconomic events. They are the US fiscal cliff and debt ceiling negotiations, China’s economic path and tensions in the Middle East affecting commodities.
Ford predicted a ‘kick the can down the road’ approach to the Eurozone for the coming year, at least until German elections are over.
The US will also muddle through its own fiscal challenge, he said, adding Fed chairman Ben Bernanke had “changed the underlying economy we invest against” by allowing inflation and boosting real assets.
China’s new leaders inherit a nation Ford says faces severe long-term challenges, “but in the short term they can achieve what they want”, thanks largely to immense currency reserves able to boost growth.
David Roberts, co-head of fixed income at Kames Capital, cautioned investors to test managers of strategic bond funds on how diversified they truly were.
“Most managers will have a natural bias to buy high yield and only use tactical opportunities around that core,” Roberts said. “Whenever a fund moves to 35% or 40% high yield, it dominates any other strategy. They are not giving you the full opportunity of high yield, nor giving the manager enough latitude to asset allocate”.
Roberts favours investment grade debt. “If rates stay low it is unlikely companies will relever and destroy balance sheets so high-grade companies are still worth holding now.”
Roberts is less constructive about high-yield bonds, which he said “are not cheap, and I am quite nervous they could be as unloved tomorrow as they are loved today”.
He added: “Even if US Treasuries move from 1.6% to 3% and things get a lot better longer term there may be a better opportunity to buy high yield, and if things get worse there could be defaults.” For Kames funds that can hold high yield, none figures in the top ten positions, and net exposure to the class is zero.
Roberts also expressed concerns about EMD. Although much money has flowed into the class recently, Roberts said illiquidity could still hit local currency paper, at just the time ‘liquid’ portfolios want to sell. “Only buying hard currency debt gives us the opportunity to sell it back to someone if we change our view.”
He noted much local currency EMD is unhedged, so if prices fall at the same time as EM FX cross-rates weaken, many foreign buyers will be wanting to sell simultaneously.
Roberts recommended investors always remember what their long-term view is.