Industry Voice: Why I still love bonds (or seven reasons to keep duration in your portfolio)


quirighetti-fabrizio-2014smallFabrizio Quirighetti, Head of Multi-Asset and Fixed Income SYZ Asset Management

Nobody really likes bonds. I'm not talking about the "sexy" high yield or emerging debt, which according to the cycle and fashion trends may be the object of unconditional love and reverence, but the basic ones. You know, the US Treasury, Gilt, Bund or JGB that now in the headlines at least, seem to offer unattractively small yields. And yet, here are seven reasons not to ignore them and keep some duration in your portfolio...

1. Because government bonds are unloved! Forget about a bond bubble. As the man in the street is heavily underweight or not directly exposed to them, he won't be able to sell something he does not have! By the way, when was the last time a taxi driver asked you about Treasuries or Gilts?

2. So, who is buying them? I mean apart from central banks. In fact, it is indirectly the taxi driver and the man of the street through life insurance or pension funds. But without being aware, like Mr. Jourdain in Molière. Moreover, as the population is ageing and insurance and pension funds are both regulated by governments ... there is no real risk that they buy less in the future. And with austerity gaining ground, supply may even be reduced or at least expected to grow more slowly going forward.

3. Unlike a stock, you know the price of a bond at a fixed date in the future. You can come up with the best analysis and research to justify an equity price target, but you won't be able to guarantee it, never mind when it will be achieved ... With bonds, yes you can! And so it is easier and more reliable to compare them, understand price trajectories according to scenarios and thus to find arbitrage/relative value in this market.

4. The coupon is known and paid, the equity dividend not necessarily

5. Corollary to the prior point: there is a kind of retraction force in bond's price. Bond's price collapses are generally limited and often quickly recovered. Indeed, the sharper is the price's fall, the higher the yield-to maturity gets...At some point, the "secure" nominal yield should mechanically become acceptable relative to the risk (essentially inflation).

6. Return isn't equal to yield thanks to the "roll down" effect. By being active enough to keep duration constant (i.e. not doing "buy and hold"), you can generate superior returns than suggested by the yield or coupon, assuming that they yield curve doesn't vary; or, contrary to belief, you can provide a cushion to the fall when rates take the elevator. The only condition is that the yield curve slope should be positive, which is the case most of the time!

7. The great enemy of bonds, inflation, has disappeared as a worry from major central banks' radar. Some of them are even actively seeking to cause it. What about a credit bubble burst in EM debt or a hard landing in China that may trigger a deflationary wind to blow on the global economy?

Not convinced yet? Just have a look at what has happened in the Japanese bond market over the last twenty-five years: despite a very small nominal yield, government bonds (JGBs) have offered very satisfactory risk adjusted total returns so far. Not so bad in a world of low growth, low inflation and thus low expected returns.




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