126. Rising inflation: We’re on the brink of something different for the first time in decades
Chris Bowie, manager of the TwentyFour Absolute Return Credit fund, talks us through bond markets...
Finding compelling investment ideas and solutions in global fixed income markets has hardly ever been more challenging than it is today.
Concerns about overheating economies, rising inflation and potential interest rate raises earlier than expected, have caused government bond yields to rise and bond prices to fall.
As Chris Bowie, manager of TwentyFour Absolute Return Credit, said recently: “Risks are high and rewards low in the bond markets right now.”
The average UK Gilt fund is down 5.7% year to date*. While other bond sectors have fared a little better, it’s only Sterling High Yield Bond that is just in positive territory, up 1.1%*.
Eva Sun-Wai, deputy manager of M&G Global Macro Bond, explained what has been happening in this video interview:
“One could conclude that markets are exhausted and investment opportunities may have evaporated,” commented Grégoire Mivelaz, co-manager of GAM Star Credit Opportunities.
“If yields remain range bound, then it will be an uphill battle to generate positive returns out of core government bond markets. So some out-of-the box thinking might be required. We believe there are pockets of value in credit markets, like in subordinated debt, for example. Here you can find a high and steady income of 4-5% and most issuers are of a very high credit quality, which can be comforting amidst all the uncertainty.”
Most subordinated debt (about three quarters of the market) is found in the financial sector – an area of speciality for the GAM Star Credit Opportunities managers. “Financials are coming out of this crisis in a position of strength,” Grégoire said. “Valuations are still low, but it won’t be long until they are back to pre-covid levels.”
Liontrust Monthly Income Bond managers, Aitken Ross and Kenny Watson, like the telecoms sector and have 17.6% of the fund invested in this area**.
“The pandemic has shown how reliant we are on telecoms, more so than we expected,” they commented. “The companies are also highly cash generative and we particularly like those that own the underlying infrastructure, like Orange (a top ten holding**) and Deutsche Telecom. BT has questions marks over its pension deficit, but it is still cash generative and able to pay its debts. Returns are solid, but perhaps not spectacular enough for equity holders. They are defensive and good for bond holders though.
“It’s also unlikely that new technology will come forward that will replace them. Instead, they will be part of the new 5G solution and have infrastructure that is fundamental to the growing economy.”
Jim Leaviss, manager of the M&G Global Macro Bond fund, is finding opportunities in the US. “I currently see good value in US Treasury Inflation Protected Securities (TIPS), which I believe continue to offer cheap insurance against the risk of a rise in US inflation,” he said. “Within the M&G Global Macro Bond fund I also have exposure to a number of currencies that I would expect to benefit from the recent strength in commodity prices, such as the Norwegian krone or the Australian dollar.”
As we’ve seen, high yield bonds have also been more robust. This is because they tend to have shorter duration (less time to maturity) so are less sensitive to interest rates, and the underlying companies tend to do better in an economic recovery.
Chris Bowie likes short-dated BBB bonds – bonds of companies just above the high yield threshold. “The yields are ok in this area,” he said. “It will definitely be a trader’s environment for a while though.”
Another area is emerging market bonds. Andrew Chorlton, global head of fixed income at Schroders, commented: “Realised and expected default rates are likely to be lower in Asia than in developed markets and emerging market corporates offer a fertile ground for investments.”
*Source: FE fundinfo, total returns in sterling, 1 January to 31 March 2021
**Source: fund factsheet, 26 February 2021