30th July 2015
Nick Hayes, manager of the AXA WF Global Strategic bonds explains why he is maintaining a defensive stance in fixed income investing in an “increasingly volatile market environment” and highlights the key risks to fixed income investors in the short-term…
Our quarterly fixed income forecasting asserted the need to maintain a cautious approach in the short-term since volatility in fixed income is likely to continue at a higher level over the coming weeks and months. The past quarter was difficult and volatile for fixed income investors; the markets underperformed initially due to the rising yield trend in Bunds, but also because of the Greek debt crisis, which impacted risky assets towards the end of the quarter.
We see two main risks for the foreseeable future, which would cause volatility to remain high in fixed income markets. In the short-term, concerns have moved from the Greek crises to the commodity sell off that has been underway. Connections have been made with the weakening of Chinese equity markets and the US deal with Iran. Either way risk assets are coming under some pressure and in fixed income this is manifesting itself in wider US high yield spreads. Generically core government bonds have stabilised at higher yield levels since the selloff started earlier this year.
What could be more critical to bond markets over the coming months is the general re-pricing of fixed income assets from a more aggressive stance by the Federal Reserve (Fed). If the Fed increases interest rates it will be the first time it has done so for over nine years. It is difficult to know how markets will respond, knowing that this will be the beginning of a process of normalisation. A faster pace of rate increases would have a negative impact across the asset class, including wider spreads in investment grade, high yield and emerging market debt.
As a result, we are adopting a more cautious stance in terms of fixed income portfolio positioning compared to the last quarter. This means reducing exposure to risky assets, buying some protection via derivatives against widening credit spreads and increasing duration. Looking ahead, adding some credit risk if valuation becomes more attractive could also be an option.
We may see a sell-off in certain assets in the event of a ‘risk-off’ scenario, but the resulting widening in spreads could also provide interesting buying opportunities. While our overall stance is currently cautious, looking past Greece, fixed income markets will be interesting and should provide opportunities to deliver returns through flexible asset allocation.”