We have reached that stage in the cycle when interest rates could be cut again but the downside is l...
We have reached that stage in the cycle when interest rates could be cut again but the downside is limited. Economic growth is likely to continue during the rest of the year but is also likely to be relatively subdued.
The emphasis has most probably changed from bonds to equities and that certainly now is the view being put forward by the majority of commentators. We would not disagree in overall terms.
There has been much talk recently about the possibility of deflation, but as far as the UK and the US are concerned, we think this is unlikely. Equally, as growth picks up we think inflation will pick up, but not so much that will cause much concern to bond markets.
One of the results of the flight to quality when the equity market was showing concerns, particularly over corporate problems, was that many developed market sovereign bonds became overvalued as investors were prepared to pay over the odds for security.
The spreads between the yields on top quality bonds and lower quality bonds widened and only narrowed when the outlook started to improve. Where does this leave the bond market now?
I think it leaves developed market sovereign debt stranded. This despite the fact the Japanese government bond market is looking historically attractive with a nominal rate of 1.70% plus 2.2% deflation to give a real yield of 3.90%. However, as the outlook for corporate bonds improves we believe there is still scope for spreads to narrow further. The emphasis in the coming months is increasingly most likely to be on higher yielding corporate debt.
An important point to consider is that higher yielding investments, whether in the UK or elsewhere, are of an inferior credit rating.
If we take the Premier High Income Bond Fund, a minimum of 60% of the fund must always be in investment grade paper, and when bonds come from developing economies they must be issues that are denominated in what used to be called hard currencies like dollars.
In addition, the managers have put strict limits on what percentage of the fund may be invested in credits of various qualities, which means that the individual security risk has been reduced by achieving a high level of diversification.
So the managers have picked a global selection of securities with yields superior to those which can be found if only selecting in the UK economy and largely removed the accompanying currency risk by hedging a minimum of 80% of it away.
They have reduced dependency on individual securities by increasing diversification within countries, governments and individual industries and sectors.
In a world full of political and corporate uncertainty it is impossible to remove all risk, particularly when providing a superior level of income, but the managers of the fund believe that the additional risks taken on as the price for the increased yield are controlled and acceptable.
Continuing need for yield.
Further narrowing of spreads.
Possibility of faltering growth.
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