DENISE COLLINS, investment analyst at City Asset Management on Bonds
In recent months, risk aversion has been the predominant sentiment throughout global bond markets.
Fears of a sovereign debt crisis saw investors flock towards perceived safe-haven assets given the increased likelihood of defaults in April and May. Subsequently, following a rebound in risk assets in June and July, it now seems growth – or rather lack of growth – is the leading driver of a new flight to quality.
German 10-year and 30-year government bond yields fell to record lows during mid-August, as did the yield on two-year gilt, while 10-year gilt yields fell to their lowest since March last year. The yield on 10-year treasuries fell to the lowest level in more than 16 months as the Fed prepared to buy treasuries in an effort to revive the slowing US economy.
Treasury bonds, bunds and gilts may continue to have their yields driven lower as investors seek safety during this period of uncertainty. Simultaneously, there is pressure on sovereign issues the market deems risky, driving up yields, as has been the case in some peripheral European countries such as Ireland. With yields on typical safe-haven assets so low, it is unsurprising to see demand for investment grade and high-yield credit creeping up.
We believe economic growth should remain positive so we are relatively bullish on credit and constructive on the outlook for corporate bonds as they remain priced for higher levels of default than are actually occurring. Many company balance sheets are much improved as a result of deleveraging, and recent positive earnings surprises have supported a rally in high yield, with US yields in the range of 7%-9%, accompanied by a strong pipeline of issuance. The developed economies’ low growth environment coupled with a stronger recovery in the developing world, should continue to offer a benign environment for corporate bonds. That said, risks abound, and although sluggish growth may increase defaults, equally a surging economy could stir up inflation.
We have allocated assets to strategic bond funds where managers have the ability to move as they see fit, between government bonds, investment grade and high-yield corporates.
It seems fair to say a trading approach has worked well for strategic bond funds in the last six months, as the calls between the asset classes have required increased flexibility given the tremendous swings that have resulted from the current risk-on/risk-off environment. In these circumstances, a diversified investment strategy is undeniably a prudent way to proceed.
Denise Collins is investment analyst at City Asset Management
