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How cash is making a comeback for bond fund buyers

How cash is making a comeback for bond fund buyers

Cash could be making a comeback in fixed income fund selectors' allocation strategies, according to a poll of leading investors at Citywire Fixed Income Retreat 2018.

With investors continually looking for new ideas, the received wisdom appears to be that is not always best to be involved in the markets, even at a time when the yield on cash deposits is alarmingly low and even negative.

Following a series of sentiment checks at the event, Citywire Selector  delves into the thinking of fund selectors, and gains exclusive insight from our head of cross-border investment research. Dr. Nisha Long.

Headline concerns

When it comes to investors’ key concerns, it’s no surprise that unexpected macro shifts feature heavily, as 34% of fund buyers said they were most concerned about a macro shift in 2018.

While 2016 saw turbulence in the market from the UK’s Brexit vote, as well as the French and US elections, 2017 was the year of no volatility – with managers from across the spectrum screaming out for just a little bit of volatility, in order to push portfolios along.

 

 

However, the spate of low volatility came to an end this week with markets across the globe selling off. Jitters over rising bond yields coincided with a jump in volatility in the US stock market, sending both the Nikkei and the FTSE into sell-off mode.

Dr. Long’s verdict: The global bonds sell-off over the past few months has, in no doubt, spooked the markets and had wider implications for equities. Markets are still vulnerable and defensive positioning is essential in this environment to weather the storm. However, fundamentals are still intact and this volatility should create some great buying opportunities.

Alternative ideas

Since the start of the year prices for developed-market sovereign bonds have been in decline, sending yields sharply higher.

Fund selectors at the event said they have responded to this by reducing exposure to the asset class with 39% believing it still has a role, albeit a reduced one. Meanwhile, 27% of attendees said they had reduced their exposure to its lowest ever levels.

Dr. Long’s verdict: Holding high cash levels is not taking full advantage of the plethora of other investments available in the fixed income universe. That said, holding a high cash level is justified while due diligence on available products is conducted.

However, cash is not earning anything just sat in a portfolio. Investors are therefore increasingly investing in bond proxies, such as equity income, to deliver yield which is a sensible alternative to cash in an active investment portfolio.

Best performers

Being flexible and having room to manoeuvre in the bond market seems to be a key concern for fund selectors, as 55% of delegates said they expect global flexible/unconstrained funds to be the best performers of 2018. This is while other assets, such as high yield, convertibles and government debt, all lagged behind.

Dr. Long’s verdict: Choosing the right fund in global flexible bonds will help limit the downside and give an extra kick on the upside as they ride rocky markets. This sector was also one of the best-performing bond sectors in 2017.

However, increasing high yield, convertibles and private debt in these strategies, means flexible strategies are moving towards having high correlations to equities. This is with the majority of these portfolios being invested in equity proxies to gain yield.

Sovereign stories

Since the start of the year prices for developed-market sovereign bonds have been in decline, sending yields sharply higher.

Fund selectors at the event said they have responded to this by reducing exposure to the asset class with 39% believing it still has a role, albeit a reduced one. Meanwhile, 27% of attendees said they had reduced their exposure to its lowest ever levels.

Dr. Long’s verdict: Investment grade sovereigns are deemed as safe havens but the risk in holding these bonds is increasing due to longer durations. We have seen reduced holdings in portfolios against the backdrop of the Federal Reserve projecting three interest rate rises this year and with the ECB unwinding its QE programme.

This all makes for a sensible reduction in holdings in this space. With the up tick in volatility we have seen treasuries finally appearing rational and providing the insurance they are supposed to when volatility picks up.

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