There’s no getting away from it – gilts ain’t what they used to be and investors are looking for alternatives for their fixed income portfolios, writes Lynn Strongin-Dodds.
There have been many false starts, particularly in the US, but the reality has finally set in – lower interest rates have become an interminable fact of life. Growth is spluttering and despite central banks’ best efforts, inflation refuses to rise. The result is tried and tested government bonds have been losing their pride of place as institutional investors veer off the traditional fixed income path.
“We really are in a world where interest rates will stay lower for longer,” says David Riley, head of credit strategy at BlueBay Asset Management. “There will be fewer hikes and it is difficult to predict when normalisation will return. The fact is that this reflects a structural decline in real interest rates that started 30 years ago and pre-dates the global financial crisis. The financial crisis has only deepened the trend which is why it will be hard to see the next peak of interest rates rising above 2% to 3% in the UK, Europe and US compared to 4% to 6% in the past.”
The good news is that the current environment has spawned a plethora of fixed income alternatives that cater to the multitude of institutional investors’ requirements and risk/return profile. The downside is that some of these strategies particularly those on the illiquid end are more resource intensive and timing entry points in today’s volatile markets is not easy. Take the first quarter, where markets spent the first six weeks gyrating over global growth fears – particularly in China – and an almost 30% plunge in oil prices. Fears abated in the second half, triggering a strong US Treasury rally that drove high-quality bond yields lower – not just in the US, but globally.
As Jon Jonsson, managing director at Neuberger Berman put it: “The magnitude of the moves are in no relation to the underlying risks and outlooks. This has led to episodes of selloffs, but pension funds need to be patient and tactical in order to take advantage of the dislocations in the market and lock in attractive valuations and better yields.”
