29th July 2015
Ariel Bezalel, manager of the Elite Rated Jupiter Strategic Bond Fund
The US central bank and Greece are causing headaches in the bond market, but select opportunities remain, says Elite Rated Ariel Bezalel.
A cagey US Federal Reserve and unfinished business in Greece will likely continue to unsettle the credit markets, but Australian government bonds may offer one route to mitigate risk, and select opportunities exist in countries such as Cyprus and India, according to Ariel Bezalel, manager of the Elite Rated Jupiter Strategic Bond fund.
“General nervousness around the outlook for US monetary policy has proved a headache for bond markets. However, we do not see the possibility of a rate hike as early as September as a sell signal for bonds. We think global growth and inflation are likely to be capped in an environment where high debt levels and ageing populations, in much of the developed world, are likely to continue to act as a large impediment to economic growth. In addition, in the US, there are many signs of ‘good deflation’ such as more efficient business processes that have been keeping a lid on inflation pressures. In this context, we don’t think the global economy would be able to handle markedly higher rates and expect any increases around the developed world to be both small and gradual. In this context, we continue to retain a bullish view towards the US dollar.”
Greece saga taking time to play out
“The Greek saga, meanwhile, will continue to dominate headlines and induce bouts of volatility in credit and peripheral sovereign debt. We believe that there will probably be further flashpoints between Greece and its creditors in the months ahead. We therefore took profits on our Greek government bond position prior to the Greek parliamentary vote on July 15th. Ultimately, our belief is that at less than 2% of European GDP, and with much of Greece’s debt held by the public sector, the fallout in the event of “Grexit” is unlikely to be a 'Lehman-style' moment.
“A sell-off in peripheral government bonds (such as in Spain, Italy and Portugal) could lead to more aggressive intervention by the European Central Bank (ECB) to keep a ceiling on yields. Given this, we believe having a large weighting in medium and long-dated triple ‘A’ rated government bonds, with the aim of mitigating deflationary tail risks is a sensible route for us to take.”
Why we like Cypriot government bonds
“We like the outlook for Cypriot government bonds, which we added to the portfolio earlier this year. In contrast to the shambles in Greece, Cyprus appears to be on track with its reform programme. Financial sector over-leverage was the main cause of Cyprus’s 2012 bailout, rather than government borrowing, and the economy has rebounded strongly in recent years. The banking sector has since been successfully re-capitalised and, although the overall level of government debt remains high, the budget performance has improved, meaning Cyprus is not breaching the EU’s excessive deficit procedure unlike some of its larger peers. The bonds currently offer relatively high yields among sovereign issuers and may become eligible for the ECB’s quantitative easing scheme.”
India remains the focus of our emerging market exposure
“We are cautious on the outlook for emerging markets, especially China, where data continued to disappoint. Our view is based on the poor economic fundamentals to be found across emerging markets and also our bullish view on the US dollar, which could create stress points in already indebted economies.
“India is a notable exception to this view. Our case for holding local currency debt positions there is based on an improving economy and our belief in the likelihood of further interest rate cuts. In addition, India imports much of its energy needs, so further weakness in oil prices should be a plus. Elsewhere in emerging markets, we also have selective positions in short-dated Russian names in the energy and resource sectors, including Gazprom and Lukoil. Investor aversion towards Russia since the Ukraine conflict began has meant we have been able to find companies with what we believe have balance sheets with the strength of many quality investment grade companies, but whose bonds trade on a yield typically more appropriate for those deemed less credit-worthy.”
Australian government bonds suffer in past three months, but added value year-to-date
“Australian government bonds are a core allocation within the portfolio. The Reserve Bank of Australia’s 0.25% interest rate cut in May lent further support to our case for holding the country’s bonds, and we continue to have a bearish outlook on the domestic economy. Our case is based on evidence of low levels of business investment, weak coal and iron ore prices, an uncompetitive exchange rate and low wage growth. We believe the economic slowdown in China will continue to dampen the economy, while the government’s strong finances should mean concerns around a possible downgrade of Australia are over-played. In our view, we would need to see a considerable deterioration in fundamentals for a downgrade to happen. Today, we consider the debt metrics for the Australian government compare most favourably versus other leading developed nations.”
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Ariel's views are his own and do not constitute financial advice.
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