As speculation on the future of fixed income continues, Laura Miller explains what is really going on in the bond market.
A trio of factors - low rates, inflation and a gradually recovering economy - create challenges for fixed income investors, and their advisers.
Today, interest rates remain near their 60-year lows. Since reaching an all-time high in 1981, ten-year Treasury yields have declined markedly and real yields (yields after inflation) on many fixed income investments remain close to zero.
Architas senior investment manager Sheldon MacDonald believes these forces are both increasing risks and creating opportunities in fixed income.
Unravelling the fixed income conundrum
"The more positive macroeconomic climate of late has created an environment that is not overly positive for developed market government bonds as longer-dated yields have risen and investors have rotated towards more risk sensitive assets.
"However, the sell-off in risk assets in the second quarter of the year created more attractive valuations for corporate bonds which continue to benefit from economic stabilisation and gradual recovery."
US Federal Reserve (Fed) policy is the key focal point of most fixed income investors.
In the US good progress is being made on cutting unemployment and, as a result, the Fed is considering options to cut its monetary stimulus measures.
This increases the risk that there will be further upward pressure on the US yield curve as market participants price in the prospect of future higher interest rates, said MacDonald.
"Ultimately, this would be negative for holders of US treasuries and fixed income securities with higher levels of interest rate sensitivity, like US investment grade corporate bonds which demonstrated this feature in the second quarter."
Rathbone multi-asset portfolio manager Mona Shah has been selling down fixed income since the start of last year, based on a lack of value and in favour of increasing her equities' exposure.
However, Shah reckons there are still opportunities in a rising yield environment such as the F&C Macro Global Bond, the Ignis Absolute Return Government Bond fund, and the JP Morgan Income Opportunity fund.
"In our view, these macro bond funds can be used for risk management purposes. They can short or zero weight interest rate risk in a more efficient manner than plain vanilla, long-only bond funds."
Aberdeen Asset Management senior multi-manager portfolio manager Scott Spencer also sees opportunities, mainly for active managers who have the flexibility to be nimble with their exposures across the fixed interest universe.
"Given the tougher environment we have shifted our fixed income exposure so as to focus on managers who are more strategic and total return orientated in their approach.
The funds we have chosen, such as L&G Dynamic Bond, and Liontrust Global Strategic Bond, have the added flexibility to prosper regardless of the backdrop," he said.
Spencer said he has maintained his fixed income exposure at 40% within the group's flagship Aberdeen Multi-Manager Cautious Managed fund - but Octopus Investments investment director Oliver Wallin said advisers are getting increasingly worried about such high levels of exposure, particularly to UK gilts.
This article continues...
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