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Special Report Fixed Income Strategy: No more easy gains

What started as an emergency measure looks like it has become a permanent state of affairs. Way back in 2008 the authorities started pumping huge amounts of liquidity into the markets in a desperate attempt to stave off global economic collapse. Eight years on, with the world economy apparently stable, central banks seem to be injecting ever more liquidity into the system.

Looked at from a longer-term perspective, such extraordinary monetary measures are simply the extension of a trend that goes back even further. The global real interest rate has fallen since the 1980s. Not only are rates in many countries and asset classes negative in nominal terms but they are also approaching zero in real terms.

This survey examines the roots of the predicament facing bond markets and considers the consequences for investors.

It starts with a question insufficiently examined by most fixed income investors. Why have rates trended downwards for so long?

This topic is the subject of fierce debate within economic circles but, despite its far-reaching practical consequences, relatively little open discussion among investment professionals. Of course it may be a subject that is being discussed in private but given its fundamental character it could do with a more public airing.

Although there are several different explanations, each with several variants, in broad terms there are two that are particularly influential. A broadly Keynesian approach contends that the developed world is caught in “secular stagnation”. According to this, a combination of several factors – an ageing population, widening inequality and slow technological innovation – means the world is suffering from a lack of demand. For that reason, the developed economies are stuck in a rut.

The most influential alternative is sometimes referred to as an ‘Austrian’ approach. It puts most of the blame for the long-term downward trend in interest rates on central banks. They have been quick to reduce rates in crises but relatively slow to raise them during booms. As a result, there has been a consistent downward bias in the trajectory of interest rates.

I outline the main elements of this debate in the first article in this supplement. However, there is a long way to go before it is resolved.

In any case, the ultra-low levels of interest rates provide the backdrop to the more everyday questions of fixed income strategy that make up the rest of the report. How can fund managers make the best of a market environment that looks far harder than that of the past 30 years or so?

Caroline Hay looks at the euro-zone, where asset managers generally see the European Central Bank programme as necessary but involving uncertain outcomes. Despite the difficult environment, many managers are still hopeful that, with a little ingenuity, they can find ways to generate returns.

Investors in US fixed income are in a different position as interest rates are still positive; indeed, the US market is benefiting as investors flee negative rates in Europe and Japan, as Chris O’Dea explores.

Joseph Mariathasan examines the prospects for emerging market corporate debt, and Charlotte Moore looks at multi-asset fixed income investment. Finally, Gail Moss considers how two pension funds are tackling fixed income investment in this difficult environment: Ircantec and the Church of England Pensions Board.

Watching how the markets evolve over the next few years will be a fascinating intellectual exercise. More importantly, it will have profound consequences for the fixed income markets and beyond. 

Daniel Ben-Ami, deputy editor, IPE

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