Rates lower for longer: the where and when of fixed income investments

9 years ago - Published in News

There is room to move in the fixed income world. More room than some weeks ago. A 6% return this year can be possible from a diversified actively managed bond fund. Here are some ideas by Chris Iggo, chief investment officer of Axa fixed income. 
“Rates are staying lower for longer” thinks Chris Iggo, chief investment officer of Axa fixed income. Fine, he is not the only one to think it after all. But what does this mean in terms of fixed income investment? It means “a 6% return this year can be possible from a diversified actively managed bond fund” on condition to “stop worrying about things you can’t control”. Global growth is still too weak and it will not allow any acceleration in the process of deleveraging (both in the public and the private sector). Furthermore the framework does not inspire a pick up in capital investment. This is the case for lower rates for longer. On the other hand also the risk of a global recession is very low. “The encouraging bits of the global macro outlook are strong job creation in the US and UK – underlines Iggo – better growth in Europe, the strength of Chinese services, generally improving bank lending conditions and less restrictive fiscal policies”. 
What kind of fixed income portfolio is appropriate for that kind of macro outlook?

  • If rates are going to be lower for longer good opportunities can be found on the longer end of government yield curves. Iggo acknowledges that a yield of 2,6% for a 30-year US Treasury is not something to celebrate but “as long as the Federal Reserve (Fed) takes its time tightening then there is no reason for the curve to steepen massively. Even if it does, one would expect that the credit exposures in a mixed fixed income portfolio would offset any duration losses from higher yields”.
  • Short dated inflation linked bonds could sound odd in a world where inflation runs low. But “although current headline inflation rates are close to zero in the developed world, core rates are higher and even if oil stays around 30$ per barrel, the headline rates are not likely to fall any further”.
  • Talking about oil? Iggo thinks that a “big macro call is that the oil/commodities/China picture will not get worse. That means there are value opportunities in the fixed income world through issues of large global oil and commodity players and through emerging market debt of commodity producers”.
  • The story is partly similar to the commodities case. Also if the fundamentals on US high yields “remain poor because of the exposure to the oil and gas sector”. Anyway there exist other sectors and one should keep in mind that “the market as a whole is pricing in default rates that are approaching the kind of levels seen in 1997 and 2008”.
  • Don’t be too scared by banks. Iggo’s view on the sector is still bearish, particularly in Europe, but “the banks are much stronger than in the past”. In Europe banks still deliver a yield that is 2 times the market average. “Tactically there should be scope for some further near-term outperformance as banks continue to take steps to improve their debt profile”. And in the United States the banking system is even in a better shape than in Europe.
  • In the emerging world there is room to manoeuvre too as “the market re-priced negatively during 2015” the “three-dimensional negative environment” made by a slowing China, rising US rates and low oil prices. “Of course –points out Iggo – the macro environment remains mixed. There are likely to be more ratings downgrades and the concerns about China and oil could easily come back. However, technicals are supportive as supply is not expected to be particularly significant in the months ahead”.

Source: Chris Iggo, Axa Fixed Income