18th February 2016
JP Morgan Asset Management Global Bond Opportunities fund manager Nick Gartside believes the economy faces two main risks: a lack of growth and a lack of inflation…
Growth and inflation are the enemies of bond investors, so if Gartside is correct, the economic backdrop should be broadly supportive for bond returns in 2016.
But with fixed income indices locked into record low bond yields, Gartside is taking an unconstrained investment approach to generate returns and gain diversification.
Below he explains where he’s finding the best fixed income ideas…
European High Yield: This is a bright spot in the global credit universe as central bank liquidity and weaker currency act as powerful tailwinds. Europe is at an earlier point in its credit cycle when compared to other high yield markets, which supports return prospects, and the market has little exposure to the struggling energy sector. Yields on European high yield may seem low relative to the US high yield market, but headline figures mask the US market’s lower average ratings quality, higher underlying risk-free yields, and longer weighted average duration vs. the European market. Adjusted for these factors, credit spreads in Europe are actually cheaper than the US. European high yield continues to benefit from improving fundamentals, meaning that an already higher credit quality market is poised to deliver more rising stars – future investment grade companies that should deliver tighter spreads and higher prices.
Peripheral government bonds: Many peripheral European countries have gone through structural adjustments already and growth is spreading from central Europe. Bouts of market volatility notwithstanding, spreads on Spanish and Italian sovereign debt can continue to grind tighter from current levels, offering attractive returns. This direction of travel may continue given the European Central Bank’s commitment to its quantitative easing programme well into 2017.
European financials: More robust post-financial crisis bank regulations have helped prompt European banks to strengthen their reserves and improve their capital buffers, which makes them compelling investments from a moneylender perspective, despite the recent volatility. We like hybrid bank capital debt although we are cautious of banks with emerging market exposure and we prefer the securities of banks that have completed their financing needs. We are focusing on high quality financial institutions in regions with strong regulatory regimes, such as the UK, Switzerland and Scandinavia, and investing in those banks that are retail-oriented.
US high yield: Despite an increasingly distressed energy sector, most US high yield companies have healthy balance sheets. As the strength of the US dollar will likely moderate in the next few months as the US Federal Reserve struggles to raise rates beyond 1% at the terminal point in this shallow rate hiking cycle, this should help bolster corporate earnings, contributing to stronger economic growth and better investor sentiment. This backdrop is a supporting factor for high yield, which shares more characteristics with stocks than with US Treasuries. Although the troubled energy sector will contribute to higher aggregate default rates, overall default rates should remain manageable.
High quality duration where value exists, including long dated corporate bonds: I see value in longer dated corporate bonds – i.e. those with 30 year maturities – where the deluge of supply in 2015 weighed on spreads. Given that the credit curve is at historical steepness, we believe this is an attractive opportunity to take the additional interest rate risk in high quality industrial names.