Written by: Nick Gartside
With a record number of government bond yields in negative territory, fixed income investors might be forgiven for thinking their options are limited. But Nick Gartside, Portfolio Manager and International CIO of Global Fixed Income, believes this is a sweet spot for bond markets, with plenty of good opportunities to find decent returns for investors who can take a flexible, unconstrained approach. Here, he talks us through five ideas he and his team think look particularly attractive over the next 12 months.
1. Oil overspill: US high yield excluding energy
In an environment of very weak oil prices, worries about the ability of energy companies to repay their debts have pushed up the yields on US high yield bonds. Energy sector bonds are really a call on the oil price—and that’s a call we’re not prepared to make. But the rest of the market has also suffered for the woes of the energy sector, and now offers some very attractive yields. The risk is that increased numbers of companies default on their debt. But we think defaults outside the energy sector will stay low, given that we don’t expect a recession in the US in the next 12 months.
2. Beyond Bunds: Peripheral eurozone government bonds
The peripheral eurozone might not look like a great opportunity at first glance: the spread between yields in the periphery and those of German Bunds has come down a long way, and these bonds don’t pay much income.
However, this part of the bond market is a big beneficiary of the effort the European Central Bank (ECB) is making to kickstart growth and fuel inflation. Economic conditions in the periphery are improving, and with the ECB’s quantitative easing program sucking bonds out of the market and other investors seeking the positive yield given negative yields elsewhere, demand is outstripping supply. As a result, we expect a capital gain in the coming year as spreads narrow further.
3. Riding the recovery: European high yield
The European backdrop is also important for the high yield sector. The eurozone economy is now growing, and the ratio of credit rating upgrades to downgrades suggests that companies are in good shape. Yields here are lower than in the US, but still around 5%, and credit quality is better. And again, in an environment of negative deposit rates and increasing numbers of bonds with negative yields, there are lots of other buyers, which is supportive.
4. Fortress financials: Selected European banks
Sticking with Europe, we think there are good opportunities in the region’s banks. Not only is the economic recovery good news for the sector, but banks are raising equity and paying down debt—and for bondholders, a bigger equity cushion and less debt is good news. It’s important to differentiate here: not all banks are equal. But for those banks where we have real conviction, we’re happy to go further down the capital structure into subordinated bonds (bonds that rank below other debt in the event of bankruptcy), where we can get some very attractive yields.
5. Looking longer: Long-dated corporate bonds
When US corporate bonds were hit by worries over energy issuers last year, 30-year bonds were sold off more than five- or 10-year. As a result, lots of investment grade bonds from strong issuers are yielding more than 5%. Long-dated corporate bonds have lots of duration risk (sensitivity to interest rate movements), but given that we don’t expect interest rates to move much, we’re happy to take advantage of the yields on offer.