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The 12 bond charts of Christmas

BlueBay AM’s credit chief, David Riley, reflects on a challenging year for bond fund managers.

While 2016 was plagued by volatility – given the US election and the ECB’s corporate bond-buying programme, among other events – this year has been far from volatile.

Many managers are hoping for just an ounce of volatility to bolster returns. In this round-up, BlueBay Asset Management’s head of credit, David Riley, looks at some of the most important charts investors should keep in mind as we enter 2018.

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Alpha over beta – Peak QE

Riley said 2017 will be remembered as an inflection point in the global investment regime. ‘As we enter 2018, lacklustre market ‘beta’ returns will have to be supplemented by excess returns generated from active and alternative investment strategies.’

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Inflation skewed to the upside

As unemployment and spare capacity continue to fall, Riley said there are tentative signs that inflationary pressures are beginning to build. ‘Investors exposed to higher duration portfolios will be most vulnerable and investors will need to pick their spots to generate meaningful returns.’

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Correlation breakdown

This year has seen populism continue to rise across the globe, as electorates across the world have become disgruntled with their current leadership.

‘Peak QE and populism implies greater dispersion and less correlation across asset markets. This broadens the alpha opportunity set and makes it an ideal environment for active managers to add value from a combination of long and short investment ideas.’

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Pricing political risk

Pricing political risk is becoming a daily chore for many fund managers, as the backdrop for countries such as Spain and Brazil have been changing on an hourly basis. Riley said politics and policy is having an even greater impact on financial markets than ever before.

‘Markets have often mispriced political risks over the past few years and those best able to access and flexibly deploy the full range of investment tools will be in prime position to exploit opportunities as well as limit drawdowns during volatility spikes.’

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The EM recovery

Emerging market strategies have been a popular bet this year, as asset management firms have scrambled to offer up new and innovative ways to play the space. However, despite a push for fund launches across the sector, Riley said there is still plenty of opportunities to be had.

‘Investment returns on EM local currency debt is underpinned by high real interest rates and currencies that have begun to recover after falling by as much 40 percent from their local peak.

'We believe the opportunity set for investors with the skillset and resources to sift through high yielding and recovering companies operating in EM has been and remains very fruitful.’

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Mind the gap

Following a painful period of adjustment following the ‘taper tantrum’ in 2013 and the collapse in commodity prices in 2015, Riley said EMs are benefiting from the synchronised global upturn in growth. ‘EM assets typically outperform developed market assets as the growth gap widens.’

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European bank healing – the draw of CoCos

Another popular instrument this year seems to have been CoCos, with managers across the traditional and alternative bond sectors being firmly positioned here.

Riley said the improving economic and political fundamentals of the European area are best reflected in the compelling returns on European bank capital instruments that continue to offer value. ‘The repair and healing of the European banking sector is still in motion, and the structural investment thesis remains.’

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Doing your homework

Riley said underlying dispersion and volatility inevitably leads to winners and losers. ‘Even in the European banking sector, its essential to do your credit homework so that you avoid the losers and maximise the number of winners in your portfolio, be it in liquid or illiquid credit markets.’

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Easy policy, fast growth

Monetary policy has been a key talking point this year, with many fund managers even suggesting the central bankers that make these policies have turned into TV superstars. Riley said accommodative monetary policy continues to be a tailwind in the eurozone.

‘Consensus forecasts for economic growth are still catching up with improving fundamentals. We believe this provides continued support for European assets including German bunds and corporate and sovereign credit.’

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Treasury curve flattening

While Riley said an inverted US Treasury curve is typically a good signal of recession risk, the lag can range from six-to-24 months. ‘We are not there yet, but we believe investor’s need to be vigilant as we approach the mid to latter stages of this already extended credit cycle.’

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Extended credit cycle – HY dispersion on the rise

Riley said in the US high yield bond market, sector and single name dispersion has been on the rise. ‘For investors, sector and bottom-up name selection remains critical to optimising returns and capitalising on event-driven dislocations.’

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Search for income – risk/reward quandary

While core fixed income government bond yields seem to remain at stubbornly low levels, Riley said traditional passive fixed income offers less reward for greater interest rate risk in the past. ‘We believe this provides the platform for absolute return and alternative investment strategies to outperform.’

 

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