Fixed income investors are being forced to rethink their approach to the market due to fundamental economic and geopolitical challenges.
That is according to BlackRock’s Scott Thiel, who is deputy CIO of global fundamental fixed income and head of global bonds.
‘We really are at cross roads in terms of fixed income investing and I think it has a lot to do with the current environment,' he said at a round table event in London.
Thiel, who co-runs the $9.50 billion BGF Fixed Income Global Opportunities fund, said the team has seen strong fundamentals and a substantial recovery from the financial crisis of 2007 and the peripheral crisis of 2010 across Europe.
‘There are a number of different indicators but most important is the employment figures in both the US, UK and many countries across Europe. Here you could argue these places are at near to full employment.
'But what does this mean for fixed income investors? In many respects, we have hit a period where central bank policy will begin to change.
'They don’t set policy with respect to each other but there has been a period of contemporaneous monetary policy tightening, which we haven’t seen since the financial crisis.'
Unfortunately for fixed income investors, Thiel said the line between politics and fundamentals is continuously blurring and he highlighted the biggest challenges for investors.
‘For fixed-income investors, the biggest fundamental focus has to be the impact of that contemporaneous hiking and tapering. That’s something we are very focused on and what it means for asset classes outside of fixed income, it is one of the biggest problems we face.
'When the ECB says ‘we don’t think the bond market is in a bubble’ I would suggest that maybe that’s not entirely true,' Thiel added.
How to position
Theil said fixed-income investors need to think carefully about how they approach interest rate risk in their portfolios and should consider a flexible approach.
‘It generally boils down to: "what should I do with the interest rate risk in a period where there is a fundamental transition in the global economy?" We do expect there to be rate increases across developed markets.’
With 9.66% of the fund allocated to high yield credit, Thiel said this is one asset the team believes will perform well.
‘In high yield, we look at higher rated companies and BB-rated credits, recognising that the spread is particularly tight to investment grade. But we also look at the idiosyncratic opportunities in the CCC space. The lower rated space where you are able to get much higher yields.'
Thiel said the team is also favouring structured products based on the fundamentals of the consumer as they continue to be attractive in the US.
'We like commercial MBS or CLOs, we also like them in the UK where we believe asset-backed securities continue to offer value. They are less interest rate sensitive because they have less duration but they also have improving fundamentals.
‘EM still has a place in our portfolio (20.77%), in hard currency with respect to dollar bond spreads which we still think are attractive.
'We are long high-yielding EM local markets where the central bank has room to cut rates, where inflation is falling and where central bank reaction hasn’t been as aggressive as it could.’
Over the three years to the end of September 2017, the BGF Fixed Income Global Opportunities fund returned 5.93% in US dollar terms.
This compares with a 8.58% rise by its Citywire-assigned benchmark, the Bloomberg Barclays Global Aggregate USD TR, over the same time period.