Will sovereign bonds remain the safe haven of choice? Or is corporate credit the only place to be? Leading fixed income fund managers, strategists and economists discusses the major themes for 2012.
The changing nature of risk is apparently set to sit at the top of most managers’ agendas over the next 12 months, with the reverberations of the eurozone debt crisis set to spill over into 2012.
In terms of corporate bonds, some managers think the market is already pricing in risk to a certain extent and a recurring theme is expected inflows into this asset type.
Here Citywire Global has collated the views of some leading investors and their outlook for fixed income over the coming 12 months.
Stefan Kreuzkamp, head of fixed income at DWS
‘The risk premia carried by European government bonds in comparison to Bunds are at record levels. Next year we will see a re-evaluation of default probabilities. Then it will be time to invest in bonds from Italy, Spain and Belgium once again.’
‘Risk around corporate bonds have already been priced in. The implicit five-year default rates are at historically record levels, even though the fundamental position of corporates is very sound.’
Kreuzkamp currently sees return opportunities in covered bonds, in bonds denominated in foreign currencies from AAA rated countries such as Australia and New Zealand, as well as bonds from selected emerging market countries like Poland and Mexico.
‘Going into 2012, I believe that sovereign and political risk (both domestic and global) will remain at the forefront of investors’ minds.’
‘Weak economic data and doubts over prospects for US and global growth will drive overall sentiment. US unemployment rates are unacceptably high and I expect downward pressure on growth from excess capacity in labour markets and industrial sectors.’
‘Whilst corporate fundamentals are still relatively strong, they are no longer improving, having come off their peak. However, with US Treasury yields at such low levels, coupled with any potential future decisions by the Fed to expand its asset purchase programme, I expect market yields to stay low, driving investor demand for assets that offer higher levels of income.’
‘This should benefit corporate bonds. Sovereign risk is much more important than industry or company risk; Eurozone problems are not going to be resolved quickly and I expect further volatility from this area.’
‘I favour high quality short-dated corporate bonds and bonds from companies in a deleveraging mode following a strategically sensible acquisition. I also expect the volatility to continue in 2012 and so will maintain a healthy position in liquid nominal US Treasury bonds and cash related instruments.’
Robert Hall, institutional fixed income portfolio manager, MFS Investment Management
‘For the near term, it appears likely that the European crisis will remain the most important driver of US Treasury yields. With binary outcomes for Europe that are largely dependent on the vagaries of policy and politics, making duration bets in the near term looks risky, while staying “close to home” with respect to interest rate exposure seems the prudent course.’
‘We believe US Treasuries offer poor long-term value; over time, as the tail risks recede, the trend in Treasury yields should be higher. In the near term, however, it is very difficult to make a directional call; Treasury rates could possibly go lower as investors seek protection against bad outcomes in Europe. Overall, we think the balance of risks is tilted toward slightly higher rates in the months ahead.’
‘While Operation Twist could push rates at the front end of the curve modestly higher, we think the yield curve will likely remain relatively steep. A US Federal Reserve Board committed to monetary policy accommodation should help keep short rates well anchored.’
‘Furthermore, the potential for further quantitative easing measures cannot be dismissed, given the threat of fiscal drag in the United States, the prospect of weaker growth in Asia (softening in China, as well as temporary weakness in Thailand due to flooding), and the sovereign debt risks of Europe.’
Specialists and strategists
Andrew Wells, global CIO, fixed income, Fidelity
‘2012 will be a challenging year for bond investors as they are forced to adapt to a changing fixed income environment by recasting their established ideas about the nature of risk. The realisation that some of the largest risks in the bond universe reside in what was seen as the lowest-risk end of the spectrum is a watershed moment.’
‘Sovereign defaults will remain the major concern for markets in 2012. However, investors should be wary of tarring all bonds with the same sovereign brush. 2012 will be a year of threats and opportunities in bond markets and nimble fund managers can take advantage of situations where investor sentiment becomes detached from the fundamentals.’
‘2012 will also see bond investors give much more weight to the idea of emerging market bonds being a structural, rather than a tactical, allocation in their portfolios.’
‘These economies are forecast to deliver the strongest growth rates, which gives sound underpinnings to their sovereign credentials. Indeed, the debt and budgetary positions of many emerging market countries is now far superior than many developed countries.’
‘Sharp drops in risk sentiment that lead to rises in the government bond yields of well-managed, fiscally responsible emerging market countries could present opportunities for income-seeking investors. Similarly, emerging market inflation-linked bonds offer attractive real yields - inflation is higher than in the West but this likely to be more than compensated by robust growth.’
Léon Cornelissen, Lukas Daalder and Ronald Doeswijk, Robeco
‘After the sell-off in investment grade and high yield bonds, prices now seem to be factoring in a recession. As the graph below illustrates, spreads in the US market are high in a historical context. On the one hand, one could argue that spreads have risen too far, given that corporate balance sheets are healthy and loaded with cash.’
‘Aside from its role as a diversifier, emerging debt offers attractive investment prospects. In the short term, the asset class will be affected by the volatility and uncertainty in financial markets.’
‘Longer term, however, the asset class should have attractive returns, based on the higher interest rates. Foreign currency exposure does add some volatility, but we believe that there is a longer-term prospect for emerging currencies to appreciate.’
‘Long-term history shows that ten-year rates are – on average – below the nominal economic growth rate. We believe this gap averages around 0.75%. With ten-year rates at 2.0%, implied nominal growth rates are thus below 3%, leaving little scope for real economic growth.
‘To us, this seems rather pessimistic on the potential for growth. Moreover, the past suggests that, in the medium term, there is a heightened risk of inflation.’
‘After all, it has helped the deleveraging process after financial crises. We therefore think that high-quality government bonds are unattractive over the medium- to long term.’
‘For an investment horizon of a year, we have to take into account the low inflationary risks and the uncertainty surrounding the eurozone debt crisis. Furthermore, short-term interest rates will remain low during 2012.’
‘At this stage, we refrain from a negative view on the asset class. But as soon as the prospects for risky assets brighten, high-quality government bonds are set to enter a period of unattractive returns.’
Ingo Mainert, global head of fixed income at RCM
‘Although spending cuts and deeper structural reforms in many European countries will be a major drag on domestic demand, we do not expect a big impact on world growth as long as major disruptions on the markets can be avoided.’
‘On the positive side we see a stabilisation of growth in the US as the very expansionary policy of the Fed seems to bear fruit.’
‘In Asia the time of policy tightening should be over and we can expect a loosening of policy in the course of 2012 as the upswing in food prices loses momentum and inflation fears abate. Therefore, a yield increase seems likely for the longer end of the curve (10 year Bunds).’
‘The current very depressed real yield level seems unsustainable as we expect some of the safe haven flows to revert. The receding inflation pressure should have no significant effects on yields since inflation expectations reflect this already. Therefore a steepening of the curve in Bunds and in periphery government bonds seems likely.’