Investors chasing yield have been warned by allocators that they should not be chasing coupons at the expense of safety.
Credit-spread volatility will continue affecting convertibles’ performance, and equity market volatility will also contribute to their future returns. “Companies are expected to use both the high cash levels on their balance sheets and future free cashflow to boost shareholder value. Share buybacks, increased dividends and merger and acquisition activity are possible uses. These factors should benefit equities and convertibles.”
Forsyth says it makes investment sense to include fixed income with an ‘equity tilt’ in the strategies.
“When high-yield bonds and convertible assets are combined with equity, they create a very compelling asymmetric risk/return profile. Equally important, they have allowed the fund to produce high, consistent income in varying market conditions since the onshore fund’s inception in 2007. Each of three asset classes is negatively correlated to the returns of investment grade credit and government debt [which] should help reduce the fund’s interest rate volatility when rates begin to rise.”
Some managers pick out specific pockets of value, and sustainable yield, in the markets.
For Alliance Bernstein European fixed income portfolio manager Jørgen Kjærsgaard, some of the European periphery’s corporates are worth considering. Some companies have pre-financed themselves to 2015, he notes. “Particularly for investors who are thinking of a longer time frame (three to five years) we think peripherals can be a robust addition to the portfolio. And it’s going to be one to watch in the coming year.”
The 4% gap between yields on Bunds and peripheral companies early this month was comfortably wider than the historic average spread, Kjærsgaard notes: “If bond prices just moved sideways, the expected excess return over [sovereigns] would be about 4.8% for the year – quite attractive under current market conditions.”
But Tim Haywood, head of fixed income at GAM, says: “Of all the premia you could chase, the only one that seems less good value at the moment [than core debt] would be investment grade credit spreads, be they emerging markets or core corporates. Spreads do seem rather tight given the lack of safe haven status.”
Spreads have been sent tighter not by the instruments being good value, but by credit being on “everyone’s buy list”.
Haywood looks to buy less-crowded markets such as US RMBS, where his team made gains shorting from 2006 to 2008. GAM is modestly short ABS of US commercial property.
Another favoured area is bonds “other people do not want to own”, but not necessarily for investment reasons. “The fact Portuguese government bonds are up 15% this year will have bypassed most clients because buying them would have been seen as a ‘career risk concept’ in January. We still believe they are under-owned,” Haywood says.