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Jim Cielinski

Bethany Payne

At a time of rising inflation and interest rates, it is easy to dismiss fixed income as an asset class, particularly since bond valuations are relatively high by long-term historical standards. However, this view neglects the wider context.
First, the valuations of all assets are high, especially equities – think of tech stocks, for example. In such circumstances, selling riskier assets such as shares and switching to a lower-risk alternative like bonds is the best way to diversify. Cash might seem safe, but it is guaranteed to lose value in real terms and dwindle quickly, given where inflation is today.
Second, investors have become overweight in equities in recent years, both through inertia as share prices have climbed so far and because they opted to avoid fixed- income assets when bond prices had been boosted by the world’s ultra-low interest rates. Rebalancing portfolios requires a shift back towards more bond investments.
Finally, higher inflation and expectations of rising interest rates have now been largely priced in by bond markets. Bond yields have risen in recent months, meaning new investors receive more interest income for each dollar they invest. Since yields move in the opposite direction to prices, that means prices are lower and bonds are now much better value.
There are real opportunities for investors in bond markets now. During the first couple of years of the Covid-19 pandemic, the big theme was how bond markets around the world converged. Governments and central banks everywhere provided huge, coordinated levels of support to their economies. Now, the theme is divergence.
Emerging market bonds offer shelter from inflation and policy tightening
Regime change is under way in the United States, Britain, Europe, Canada and Australia. They are now focused on how to tighten monetary policy to squeeze out inflation through higher interest rates and with tentative steps towards unwinding their quantitative easing (QE) programmes.
The end of QE is less of a concern for bond markets than is commonly perceived. The reduction in central bank demand for bonds comes amid much less new borrowing by governments as economies recover, so the supply of bonds is also falling and helping offset the drop in demand.
In Japan, the central bank is more cautious and has yet to commit to either higher rates or quantitative tightening, with bond purchases continuing. Meanwhile, the Chinese central bank is doing the opposite by stimulating the economy with looser policy. This means bond markets are behaving differently from one part of the world to another.
As well as geographical considerations, there are opportunities in what sort of bonds to buy. In particular, investors must think about longer-dated bonds versus those set to mature during the next five years. First, investors can protect against losses amid rising interest rates by buying shorter-dated bonds. Their prices are less volatile because they are certain to repay their capital soon, making them less susceptible to changing market conditions.
Fed, HKMA rate actions likely to have mild impact on commercial properties
The “short end” of the yield curve is a good place to hide. Markets also seem to be expecting more interest rate increases than are likely to materialise. This means shorter-dated bonds will benefit if the tightening cycle ends sooner.
Second, the yield curve has flattened. That means there is little difference between market interest rates for bonds that have only a couple years left to run and those with 10 years or more. Long-dated bonds are riskier, but the compensation for that extra risk through a better yield is low, so there is little incentive to take it.
Third, though it remains true that sovereign bonds offer little income for a given level of capital and income investors might prefer higher-yielding corporate bonds, they are the right place for those wanting to minimise risk in uncertain times.
Finally, the terrible human cost of the conflict in Ukraine is changing the fiscal outlook for governments. For example, Germany has ramped up its defence spending, committing €100 billion (US$108.1 billion) of its 2022 budget to its armed forces.


The question of energy security will have to be answered with significant investment. These fiscal pressures will confront all governments to varying degrees in the years ahead, and another round of QE might be necessary.
This is a dangerous time to be a passive investor. The theme of divergence is a cue for more volatile markets. This is a time to be selective, picking the geographies and maturities that either offer opportunity for capital gains or a place to hide from losses.
Simply holding the index cannot offer these advantages. The bond markets are large, deep and complex to navigate, so whether the investor is a big institution or a private individual, active funds offer a convenient, diversified access point to this asset class.
Jim Cielinski is global head of fixed income at Janus Henderson Investors, where Bethany Payne is global bonds portfolio manager.


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Opinion

Business


There are real opportunities for investors in bond markets provided they pay attention to geographical divergence and maturities that offer either an opportunity for capital gains or a place to hide from losses



There are real opportunities for investors in bond markets provided they pay attention to geographical divergence and maturities that offer either an opportunity for capital gains or a place to hide from losses.


Central banks

Quantitative Easing

Interest rates

Macroscope

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Column