By David Rolley
David Rolley, portfolio manager and co-team leader of the global fixed income group at Loomis, Sayles & Company
While the great hunt for yield continues, institutional investors can take some comfort from the current market environment for global risk asset classes. Back in February we saw the absolute worst levels for these, with stocks down hard and oil prices at a low. However in recent weeks we have seen a worldwide risk recovery – be it a cautious one, resulting in revived global credit markets and attractive total return investment opportunities for institutions.
The recovery is being driven by a modestly higher oil price, the announcement by Russia and Saudi Arabia that they would cap output – and their intentions to persuade other oil producing countries to do the same, and slightly improved data out of China. There have also been important policy interventions: the Japanese have gone to negative interest rates as part of their policy toolkit; and the ECB measures, which quashed investor fears that Central Banks were out of ammunition when it came to restoring liquidity to global bond markets. Added to this, the US Federal Reserve has taken a softer line on future interest rate hikes, while Chinese authorities reinforced their commitment to renminbi stability.
So following the recovery, where do the opportunities lie? Treasuries worldwide do not represent a compelling value proposition; over 20% of global treasuries have negative yields, which means they eat into capital. What’s more, extending up the maturity curve to get a positive yield is a value trap, because yields are so low that when you compare the incremental income to the price risk you take for owning long bonds the upside is minimal.
Worldwide credit, however, is an attractive investment. Credit spreads, which widened out with equity weakness and concerns about global growth, represent a far better value proposition, and unless the world goes into a recession, investors will make money owning investment grade credit and this is true both in the U.S. and in Europe – although for different reasons.
In Europe you have the tailwinds of the ECB measures. Firstly, its move to encourage commercial banks to hold fewer reserves and make more loans, by allowing banks to borrow from the ECB at a negative interest rate if they grow their loan books. Secondly, the ECB’s decision that it will be buying investment grade Euro pay non-bank corporate paper as part of its QE programme later this year. This is a huge development that is having a profound impact on Eurozone credit spreads which have rallied, and on investor appetite for new transactions – as they expect to be able to sell their paper to the ECB for a modest gain later this year.
The UK remains a wait and watch situation, as while there is a yield advantage in the sterling credit market there is clearly a volatility and price risk associated with the uncertainty and narrowness of the polls on the Brexit referendum.
On the emerging market front, the dollar pay bonds, either Government or corporate, do represent value in a number of countries. For example, Mexico presents an attractive investment opportunity as does Indonesia. In the case of EM currencies, it’s a more complicated story. Right now we’re having a relief rally in EM currencies which could extend further, because investors were looking for a Chinese devaluation which did not happen. The general feeling is that the Chinese will hold on to their currency peg for a while, but until there is more clarity on Chinese data or a stronger view on worldwide oil supply and demand, the rally in EM local currency will be limited.
Institutional investors should therefore be using global fixed income, and in particular global credit, for total return generation, rather than LDI immunisation. The current yield environment remains too low to be beneficial for LDI purposes; if investors are patient better opportunities will present themselves in the next couple of years, as the unconventional yield suppression we are seeing wears off – particularly in the U.S. dollar market as the Fed is likely to raise rates this year, leaving us with higher yields as we move into 2017. In terms of the best investment opportunities for a healthy global bond portfolio that earns positive returns, investors should be focusing on global credit, including EM credit, and EM local currencies once there is more clarity on the China and oil price front.
