Running out of options
Just how much value is left in bonds, regardless of geographical origination or type is arguable. That said, there is little value to be had in equities either, so bond investors should not feel too bad, but now is the time to be looking at where returns can be found.
The 50bp cut by the European Central Bank back at the beginning of June had been anticipated and priced in, leaving little value across the curve. Yes, further cuts are expected and hoped as the threat of disinflation continues to loom alongside an uninspiring economic outlook, but the ECB could well rest on its laurels for the summer, and no one is entirely sure when the next cut will be. Even the belly of the curve, which has been relied on for some value over the last few months has begun to struggle on the back of technicals. “The short and long end are more interesting now than the belly of the curve, but we prefer to stay underweight in duration,” says Alan Cauberghs, head of fixed income at Dexia Asset Management in Brussels.
On a global scale, Europe is still seen as the ‘best of a bad bunch’. “European bonds are not cheap by any means, but they are less expensive than US Treasuries,” says Lee Thomas, finance director at PIMCO. In June, the Federal Reserve surprised some investors by cutting only 25bp. Clearly a cautious move, the disappointment in the market saw the long end of the curve perform badly immediately after. And still the long end is an unpopular choice – although this depends on your outlook for the economy. Explains Thomas: “If you think that the US and Europe are headed down the same path as Japan, or that the Federal Reserve is going to be aggressively buying long bonds, then you could argue that yes there is still value at the long end of the curve. But if you believe that the economy is going to turn up and that inflation will be higher then there is little value. For example, if a 10-year bond is yielding around 3.75% but inflation is expected at 2-3% then there is virtually zero returns on long bonds.
In the corporate bond market the mood is equally down-hearted. Credit spreads are expected to come down to levels which do not represent value over the coming months. The question of a ‘bubble” is on the minds of many asset managers. Denis Gould, head of fixed income in the UK, of AXA Investment Managers in London believes that there is a bubble building and that it could inflate further. “There is so much money chasing corporate bonds whether from pension funds or retail investors. There’s not much issuance either and any issuance that does arise gets gobbled up.” Advises Gould: “It’s still very name-specific, and the trick is to manage stocks actively, avoid problem bonds, and take advantage of credits which are volatile without an underlying fundamental cause.”
Cauberghs agrees that to find value in the corporate bond market you have to be look carefully. ‘Autos remain very volatile and will do for the coming months as a result of their pension funding problems. Telecoms, on the other hand have tended to perform well and the banking sector also.”
Adds Henk Beets, head of institutional investment in Europe at Vanguard Investments Europe in Brussells: “You must be careful not to just chase past performance.” Indeed this will only exacerbate a bubble, and as Thomas points out, the twenty years bull market in both bonds and stocks that has now finished will probably not be seen twice in a lifetime.” It appears to be time to come up with original strategies in order to find value now in bonds.