Investors chasing yield have been warned by allocators that they should not be chasing coupons at the expense of safety.
In the long run, high-yield bonds in the US have displayed equity-like returns with half the volatility. “Looking forward, we do not foresee a spike in US default rates any time soon, and in a low growth environment in the US, we think [companies] will keep paying coupons and pay down their debt,” Douie says.
Steve Huber, fixed income portfolio manager at T. Rowe Price, agrees a ‘broad view’ of the asset class is important for fixed income. He says: “If you are concentrated in Treasuries, or just developed market debt and getting a low yield, if rates go up you need some exposure to high yield and emerging markets debt as well, to get additional yield.”
Strigo advises taking a similarly broad approach, within EM debt: “It is possible to construct various portfolios including blended funds, where the final investor can give the asset allocation decision to a fund manager like us because, even for the next year, it is difficult to predict which [part of EMD] will outperform, a lot will depend on the global economic cycle and what the US is doing.
“If there are rate rises the hard currency portion will be under pressure, but local currency would perform better, because if inflation in EM is not the main concern at that point if global growth is improving, it would be better for FX and it would make sense to allocate more to FX or local currency bonds.”
Jan Dehn, chief strategist at Ashmore, says blended EMD funds make sense because shocks from the indebted advanced economies hit different parts of EMD at different times. “The mispricing of EM asset prices during heavily indebted developed countries-panics’ often affects different asset classes to different degrees.
“In the past couple of years it has become customary for the market to vent its HIDC fears in the currency markets, more so than in the credit space. When HIDC panics impact the relative opportunity set within emerging markets, it is possible to add alpha not just by buying dips, but also by rejigging the portfolio.”
One manager taking fixed income diversification a step further, to convertibles and even dividend yield, is Allianz Global Investors’ Doug Forsyth. The Income and Growth strategies he runs made about 12% annually over three years from each of convertibles, high yield and US equities.
Forsyth comments on these three sleeves: “Nearly all strategists agree that the outlook for credit is constructive, with minimal defaults projected for 2012 and 2013. The combination of healthy balance sheets, low defaults, accommodative monetary policy and the pure lack of other yield options for investors has driven the market higher. Year-to-date, high-yield bonds’ low-double-digit return has met many strategists’ full-year return targets. If rates and the environment remain in their current condition, a coupon-like return should be anticipated over the next 12 months.”