Ken Van Weyenberg, investment specialist at Dexia Asset Management has outlined the options for fixed income investors at a time when government bonds have become expensive and downside risk has increased.
Many investors are wondering whether it is still worth the trouble to invest in high yield, after a narrowing of the spread and exceptionally strong performances in both the United States (+15%) and Europe (+26%) over the past year. Given the current macroeconomic context, the budget-related efforts being made and the expected increase in the number of payment defaults, the reduction in spread (price effect) will be limited. Yet the high yield markets remain attractive as the result of the positive carry effect in an environment of low rates. Investors aiming to build diversification into their bond portfolio are seeing particularly strong opportunities for American short-running high-yield bonds.
Convertible bonds are also attractive at present in small doses. A convertible bond can be converted into a predefined number of shares in the underlying company at a price established in advance. Consequently, movements in the value of such an instrument are linked closely to the price of the underlying shares and only to a lesser extent to the bond market. As a result, investors can benefit partly from a rise in the equity market, while any drop is smaller if the equity markets fall. The appeal is that valuations are currently attractive and are supported by various factors, including the increase in mergers and acquisitions, the number of forthcoming maturities and the high cash level in investment funds. Through the addition of convertible bonds, it is possible to increase the yield of the portfolio considerably without having much effect on volatility.
The halcyon days of the bonds markets may be behind us, with equity markets coming back to the fore, but the ‘great rotation’ out of bonds has largely failed to materialise. A balanced bond portfolio is still able to deliver an attractive yield, provided it is sufficiently diversified and the interest rate risk is limited. Of course the expected yield is a good deal lower than that of equities at present, but adding 15-20% of shares to a bond portfolio should increase an investor’s expected yield without sending the volatility of the portfolio too high.