Australian bond investors shouldn’t let global market volatility deter them from considering the advantages of a global, multi-sector investment strategy, according to asset manager AllianceBernstein (AB).
“Even in the euro-area, where concerns about Greece’s possible exit from the currency have stirred an atmosphere of crisis, a dynamic approach unconstrained by attachment to a market benchmark can uncover attractive opportunities,” says John Taylor (pictured), Portfolio Manager – Fixed Income.
London-based Taylor is visiting Australia to engage with clients interested in diversifying their fixed- income strategies beyond the domestic market.
“Australian fixed-income investors are like those anywhere else,” says Taylor. “What they want is negative or low correlation to equities, wealth preservation, a smooth path of return, limited drawdown (especially when they are close to retirement), above-cash returns and greater diversification.
“Their options compared to those of their counterparts elsewhere tend to be fairly limited, however. Typically Australian investors are faced with low cash rates, hybrid securities which rank behind debt in the event of liquidation, increased reliance on equities for income, limited supply and accessibility of domestic corporate bonds and a market which is heavily influenced by global factors.
“In light of this, it seems sensible to consider diversifying into a broader opportunity set, and we think a global, multi-sector strategy unconstrained by market benchmarks fits the bill.”
The key to such a strategy lies in research, says Taylor, who pointed beyond the current focus on Greece to the quantitative easing (QE) programme of the European Central Bank (ECB) as a driver of recent volatility in European bond prices.
Its monthly €60 billion (A$87 billion) purchases pushed yields on European government bonds into negative territory in April. The following month, however, slightly better economic data prompted speculation that the ECB might rein in QE, sending bond yields higher and prices lower.
According to Taylor, the intensity of the sell-off was a result of investors attempting to exit trades which had become crowded by the market’s one-way bet that QE—which is set to run to September 2016—would continue to drive prices higher and yields lower.
European markets have since regained equilibrium, but Taylor expects volatility to return later this year as a result of a fall in the supply of bonds (caused by the fact that many government borrowers, attracted by negative yields, frontloaded their bond issuance to the start of the year).
“Investors can respond by moving away from the crowd,” says Taylor. “In particular, we think the recent widening in peripheral spreads and move higher in core European government bond yields has opened up attractive buying opportunities in higher-yielding longer-duration bonds.
“Yield curves in Italy and Spain are relatively steep, so their longer-term bonds offer a nice yield pickup—30-year Italian and Spanish debt is yielding around 3.5 per cent, compared with the less generous 1.25 per cent on offer from their countries’ five-year bonds.”
Taylor pointed out that these yields were back to where they were before QE began and are likely to fall again (as the underlying bond prices rise) when the expected supply shortage becomes evident later in the year.
“This underlines that opportunities are always available in fixed-income if you know where to look for them, and that investors shouldn’t limit themselves to one market if they want to improve their prospects for risk-adjusted returns,” says Taylor.
He warned, however, that investors considering buying into European bonds should not look at QE as a one-way bet on rising prices, and that they should think twice about government bonds whose return potential relies almost entirely on the prospect of price gains.
“They should focus instead on higher-yielding assets whose income cushions offer a buffer against any hits to capital returns if turbulence strikes again,” says Taylor.
“Paying for the privilege of lending to governments—which is what investors are doing when they buy negative-yielding government bonds—is not a sound long-term investment strategy.”