With low yields and negative rates, bond investors would be forgiven for pulling up their defensives in the current market, but are there adequate areas to turn to even then?
Citywire Selector canvassed leading bond managers to see where they stand on safe haven assets, if such a thing even exists in the current climate and how they expect their existing exposure to pan out.
Reduce interest rate risk
The current environment is a real test of fixed income investors' mettle, says Generali Investments' Mauro Valle, who is Citywire AAA-rated.
Economic growth is improving in the eurozone and monetary policies are likely to remain supportive in the months to come, as inflation is hovering just above 1%.
This scenario is set to continue, so investors should increase their exposure to riskier assets, much more so than they have over the last few months.
Paradoxically, this should be negative for euro government bonds, as such an environment might lead to higher rates. Against this backdrop, our investment strategy is to be more defensive and less exposed to interest rate risk. In this sense, it seems appropriate to reduce portfolio duration.
On the other hand, if there was an economic slowdown caused, for example, by higher rates, European government bonds could benefit, as this asset class tends to be the natural choice for investors looking to go more defensive.
Don't get drawn into a yield hunt
The key to safety is flexibility, says Hermes IM's Fraser Lundie. The Citywire AAA-rated manager is mindful of not over-reaching at such a fragile time.
It is important to look beyond the headline indicators of risk. Stubbornly low yields and low volatility in recent years have compelled yield-seeking investors to increase allocations to high yield bonds, and short duration solutions have been aggressively manipulated to retain the yields of the past.
This year the volatility of high yield credit has fallen below that of investment grade credit, but there is no reason to believe that low volatility is the new normal. Even though market conditions are stable, investors should appreciate the latent risks.
To achieve an attractive yield without taking on the risk associated with a significant allocation to high yield bonds, investors must actively manage the size of their positions and select securities carefully at a time when convexity, duration and liquidity risks are as key to success as finding the right company. To do so, it is important to have a truly global, flexible, risk-focused mandate.
Playing against 'poor value'
Multi-asset specialist and Citywire AA-rated manager David Coombs of Rathbones believes there are solid reasons for bond buyers to be defensive at the moment.
There is a place for safe havens right now. I think fixed income markets look pretty poor value. Even if it were sterling bond markets with the Consumer Prices Index at 2.9 and the Retail Prices Index at 3.9, you have significant negative real yields.
That is pretty unattractive. Most income-producing assets look pretty unattractive at the moment given the rates of inflation.
In the wider global context, there are sectors that you wouldn’t want to invest in which are fully valued. There are some massive structural shifts going on. I don’t really like property, fixed income or bonds, and that leaves you with equities, which are quite highly valued.
With that as a backdrop, having some safe havens makes sense, just in case the rest of the world wakes up and decides all those asset classes need to be de-rated for a little while.
Over the last six months we have been slowly adding safe havens. We hold gold, put options, Swiss franc corporate bonds and a lot of cash, which is the ultimate safe haven. We also own a lot of US dollars and yen, so we have a pretty diversified portfolio right now.
These comments originally appeared in the October edition of Citywire Selector magazine.