Asset managers on both sides of the Atlantic share views on the outlook for fixed income, with a focus on investment-grade debt and high-yield bonds.
The case for holding bonds has been put to the test as yields have risen in the past year on the back of higher interest rates. Three wealth management houses – Edmond de Rothschild Asset Management, Payden & Rygel, and Franklin Templeton Institute – are smiling on the asset class.
Benjamin Melman, global chief investment officer at Edmond de Rothschild Asset Management, says the firm continues to be overweight in bonds compared to equities.
“Bond markets have been falling since the beginning of September, sending yields on 10-year US Treasuries and the equivalent German Bund up by 60 basis points and 40 basis points, respectively,” Melman said in a note. The move higher has been accompanied by significant yield curve steepening.
He underlined how a recent survey from the US Federal Reserve, based on a wide sample group, shows that around 37 per cent of companies, most likely non-listed small and medium-sized enterprises (SMEs), essentially are in financial distress. “It is reckoned that bank loan interest for a US SME is roughly 9 per cent while a 30-year mortgage costs almost 8 per cent. Average credit card interest is 23 per cent,” he added.
Higher rates feed through to economies in very different ways but always slowly. He believes that these factors could lead to instability. For example, when the US slowdown starts, companies will have to deal with a drop in sales while their financial costs will continue to rise. The yield on 10-year bonds has risen by almost 1 per cent since the beginning of summer so he does not rule out other accidents of the Silicon Valley Bank type.
These factors have helped to lead the firm to maintain a cautious stance on asset allocation. It is still overweight in bonds and slightly underweight in equities. “Recent events in the Middle East and the risk of the conflict spreading are another reason to be cautious,” Melman said.
After the tech sector boom, he is now focusing on the big data theme to cash in on the artificial intelligence revolution's spread to the wider economy. He also likes healthcare. The sector has lagged but will benefit from numerous therapeutic breakthroughs and it generally performs well in more testing economic conditions. In fixed income, he continues to focus on European investment grade debt and good quality high yield bonds. The asset manager is positive on US investment grade and US sovereign bonds.
The comments come at a time when yields on bonds have risen, creating headaches for debt-laden governments around the world, such as in the UK, the eurozone and US. After years of ultra-low rates, the shift has put the state of public finances, and bond markets, under the microscope.
US high yield bonds
Meanwhile, Jordan Lopez, CFA , director, and Nick Burns, CFA , high yield strategist at Payden & Rygel|, talked about the the benefits of US high yield bonds. “High yield bonds have outperformed several fixed income sectors year-to-date. The category is up 5.9 per cent through September, ranking it among the best performers in the fixed income space,” they said in a note.
Outlining factors contributing to the market’s strength, they said inflation is improving and there are few signs of recession, which keeps default forecasts low. “Macro data, particularly growth and employment, is also coming in stronger than expected and there are resilient corporate earnings,” they continued. “Yields are once again high in the 9 per cent range,” they added. They believe that patience can be rewarded in this asset class, and investors should not try to time markets. Given the strong fundamentals and the high starting yield, Lopez and Burns believe that now is still a good entry point into the high yield market.
Stephen Dover, chief market strategist at the Franklin Templeton Institute, also thinks fixed income deserves more love this year. With valuations in better shape, inflation slowing and volatility down, the firm said that the case for fixed income today is very strong. The highest quality areas of the credit market have become more attractive, providing higher yields in investment-grade bonds relative to the dividends from equities. Emerging market debt is another opportunity, the organisation said. See more here.
Swiss private bank Lombard Odier also leans towards fixed income, with a preference for US Treasuries and investment grade credit over high yield, and sees selective opportunities to earn attractive carry in emerging market debt. See here.