BAM head of fixed interest believes european bonds a better prospect than those of US and UK
ow is the time to avoid gilts as they are destined to underperform other fixed interest asset classes. That is the view of Marino Valensise, head of the fixed income and credit team at Baring Asset Management.
Valensise believes gilts and Treasuries should be underweighted in favour of their European equivalents. Those wanting UK exposure should opt for UK index-linked gilts, he said.
'If you want to hold government bonds, you need to be in Europe,' Valensise told delegates at Investment Week's conference in Portugal earlier this month.
'The potential for economic recovery is much stronger in the UK and US and, in a recovery, gilts will be hit first. By contrast, with Euro government bonds, there are still capital gains to be made.'
Despite the fact it appears Germany has slipped into recession, European bonds are still trading at a strong level and performing well, he added.
Valensise believes index-linked gilts are a good alternative to conventional UK gilts.
'Not only do they offer a higher yield than gilts but they protect your capital in case inflation stays high,' he said. 'Currently, inflation is 3.1% in the UK. It was expected that after the war the oil price would go down and inflation would fall. Now there is the weakness in sterling, 3% inflation may be here to stay.'
Even so, overseas index-linked gilts such as those issued by the French and US governments still offer higher yields than those of the UK.
Valensise believes another area demonstrating potential is overseas high-yield bonds. A chart of S&P 500 returns relative to those of US high-yield since 1985 shows how this latter asset class has achieved returns similar to equities over that period. However, the downside has been limited.
Since 1985, there have been only four years in which US high-yield has made losses. In each case, the magnitude was small, at around 1%-2%. Equities, by contrast, have lost more than 20% in recent years. 'There is no protection if you buy the S&P 500 but you do have protection if you buy US high-yield,' Valensise said. 'That is because the starting point with high-yield is the coupon, which is 10%. Even if you lose 10% on the capital, you break even.
'High-yield bonds have traditionally performed well in a recovering economic and equity market environment. There is therefore a strong case for US high-yield, which can provide upside participation in a rally but protect capital if the stock market weakens.'
Valensise conceded the default rate is high but noted it has peaked so should fall from here. Meanwhile, companies are repairing their balance sheets, which is sending a positive message to the market, he said.
High-yield is particularly suitable for clients who want fixed income exposure not correlated to government yields and interest rate movements, he added.
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