If economics is the dismal science, then bond markets have certainly been obeying its laws. Range bo...
If economics is the dismal science, then bond markets have certainly been obeying its laws. Range bound, and suffering from low trading volumes, markets are delivering indifferent returns.
Even the best performing bonds, US Treasuries in the year to date, have only just outperformed cash. In the corporate sector, bonds have turned in some of their worst performances in over 10 years, without even the excuse of imminent economic recession.
Disappointing price action is becoming a kind of self-fulfilling prophecy. If markets are to break out of these doldrums, it seems it will take a sizeable external shock, of a disinflationary or deflationary nature, to shift sentiment. It is extremely difficult for fund managers to add value in these circumstances, without taking substantial risks. Low nominal yields and relatively flat yield curves mean cash offers very little additional value in itself.
This is a problem for index linked funds. Back in the days of high nominal yields, index linked bond prices had to keep moving up just to compensate for the lack of running yield.
Fund managers with a reasonable understanding of the market, with access to liquidity and the courage to actively manage large cash positions, could add a lot of tactical value. Today, risk positions need to be in distinctly uncorrelated assets to make any impact on fund performance. The old stories of managers stuffing index linked funds with equities and fixed income bonds may be coming round again.
Opportunities afforded by corporate stocks, or overseas government index linked do not offer a very attractive risk/ reward trade-off. There is no technical reason why these markets should be highly correlated. Despite the recent strength in oil prices, and the expectation this will persist through the winter, it is unlikely that final price inflation will shift dramatically.
On average, OECD inflation is likely to be closer to 3% than 1% over the next year or so, but this is hardly in the same league as the early 1990's experience.
Relative to fund benchmarks we would overweight corporate credits as our biggest risk position. This is particularly true for the UK. We would agree the situation is less secure in the US or Europe, where investors are less particular about covenants, and bondholders are more likely to be disadvantaged by corporate activity as a result.
The risks of investing in corporate bonds are not negligible. If the world is about to face an economic slowdown, then some corporate credits will inevitably deteriorate.
Some bonds, which are investment grade today, may well end in default. Sub investment grade paper is already experiencing an increase in default rates. These risks are already priced into the market.
Christine Farquhar is head of fixed interest at Clerical Medical Asset Management
Succeeding co-founder Simon Rogerson
Janus Henderson Global Dividend Index
More than 10 million shares allocated
Long-term strategic holding
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