Expert: David Roberts, Head of Fixed Income, Nedgroup Investments Moderator: Sascha Calisan, Director, Davies Group
Headlines:
- The sharp reversal post-Covid creates a value opportunity but not a growth opportunity
- When considering core fixed income, the ‘beta’ is back. Alpha opportunities are abundant, from a single sovereign market to the opportunity in credit markets
- The approach for core fixed income should be: to be in it for the long term and don’t believe the ‘Bulls’
Context:
The three main sales pitches being delivered to investors as late as 2020 for bonds in a negative yield environment were:
- Capital gains, as an equity diversifier, and the unconstrained fund.
In 2019 there was still around $15 trillion worth of debt globally on negative yields with investment managers still pitching bond strategies:
- Capital gains - when yield is zero assume you’re going to get more and more negative with respect to interest rates in order to generate capital gains on your underling securities
- Equity diversifier - bonds could offer protection should equities fall off a cliff
- Unconstrained fund - a big style drift in the market in most bond portfolios. A move away from core assets such a G7 government bonds and investment grade into high weightings, high yield, subordinated equity, etc.
The sharp reversal post Covid meant that the raw return on bonds – the beta – is significantly more attractive today that it was a couple of years ago. In many ways, particularly if you adjust for likely inflation going forward, bonds are probably as cheap as they have been since the 1980s.
Discussion in the room about what it was like during this period, inc: the “Emperor’s new clothes” of holding fixed income and chasing the asset class, how with negative yields you’re guaranteeing getting less back in the future, being underweight in fixed interest but overweight real assets,
Where are we going?
Bonds went from everyone’s “darling” and to costing everyone a fortune. Suggestions of a bull market are unlikely but there are solid reasons to be positive with respect to longer term return.
The challenge for the ‘bull story’ for bonds (the 4% today, 2% tomorrow people) is that fiscal policy hasn’t gone away. The G7 is generally still in expansion mode, albeit to a less extent (and some of the budgeting measures signed by Biden a couple of years ago which are still just coming into force). So, there is still a likelihood that inflation is going to hang around a little bit longer.
Other considerations include:
- Impact of a decline in globalisation and more restrictive labour policies that impact labour mobility
- Change of central bank targets, and the state of US and EU inflation in 5 years. A lot depends on where inflation is going to settle, but if inflation targeting remains at about 2% and is successful in helping inflation average that kind of level over the next 10 years, then core fixed income (especially sovereign debt) is around 4%. Plus, interest rate curves at the moment pretty flat, and some inverted.
There are three possibilities: bonds go up, they go down, they move sideways.
- Unlikely to fall significantly (i.e. the 10-15% we saw a couple of years ago) without a return to the oil shortages and crazy prices of the early 1970s w, and central banks aggressively upping rates as a result
- More logical that we’re either in the bull market and probably see yields collapse precipitously; or
- Yields remain at a high level – maybe not quite where they are today – for the next few years
Key takeaways:
- Current yields are quite attractive, and not likely to collapse anytime soon, but more crucially this is a ‘once in a generation’ type of opportunity to buy bonds
- It is not a case of a ‘New Normal’ (i.e. pile it high, ignore the risk), but rather an ‘Old Normal’ (i.e. bonds for value with a steady beta and enhanced by alpha)
