19th May 2015
As talk of a bond bubble continues, two fund experts share their contrasting views on the prospects for fixed income investors….
Jenna Barnard, director of retail fixed income at Henderson, says:
The high yield market has been a perennial target for ‘bond bubble’ commentators in recent years. To illustrate, Financial Times headlines dating back to 2011 have warned of a coming downturn in the market: “Heyday for the high yield market”, “Investors ready for high-yield sell-off”, and “High drama looms for high-yield bonds”, among others.
Given our various funds’ weightings in this asset class, clearly we haven’t been subscribers to a superficial analysis, which expects the next downturn to be a carbon copy of the last. However, it is worth updating our current view on the high yield market and where we are seeing opportunities within this.
We have participated in very few of the new issues coming to market. In Europe, at the time of writing, there have been 92 bonds issued so far in 2015. Our desk has participated in only c.10% of these. This would suggest a significant degree of bearishness on the market.
However, this is largely a reflection of the yields on offer and not the credit quality of the companies issuing the debt. Indeed, the quality of issuance year to date has been much improved from last year. 55% has been rated BB (as compared to 36% in 2013 and 38% in 2014). The number of first time bond issuers in Europe has also fallen to half of that seen in both 2013 and 2014 with a corresponding decline in CCC issuance. The surprise default of Phones 4U and the travails of the energy sector in the US high yield market appear to have injected a degree of discipline into the investor base. In addition, cross border issuance has been led by well known BB US names such as US packaging company Crown Holdings.
By extension, we would expect the default rate to remain at extremely low levels for the next 12-24 months. Even in the US where energy comprises 14% of the high yield index, there has been a wave of new money available for stressed companies to refinance existing bonds. $16bn of equity has been issued year to date by US high yield energy companies and a similar amount in bonds.
The recent sell-off in government bond yields has caused a notable re-pricing of the lower yielding BB names in Europe, but not enough to attract us. Recent BB issuance often came to market at yields as low as 2.5% — this is not a natural home for our investors’ money. We would need a more prolonged re-pricing of bond yields (akin to the ‘taper tantrum’ of 2013) to start to generate yields that look appealing to us. Indeed, our fear is that this area of the market where yields have been so compressed, often by investment grade investors looking to enhance return, is still far from the level that a traditional income investor would consider attractive. The concern is that this area of the market may be somewhat in ‘no man’s land’ in terms of where a new buyer base may step in.
Guy Stephens, director of Rowan Dartington Signature, says:
One of the worst sins of investment decision making is procrastination or, more specifically, putting off making a difficult decision because doing nothing is easier. This is most common when facing a loss on an investment, when the investor’s desire to avoid crystallising the mistake overwhelms rational decision-making. The way around this is to ignore history and focus on whether you would buy the investment today if you didn’t already hold it. If the answer is no, and if you would experience a sense of relief if you didn’t hold it, then you should sell it immediately and move on. The only reason you are holding onto the investment is to try to repair the damage and avoid the mistake.
Invariably the investment will continue going down as the situation gets worse, the position then becomes ever more painful, your focus on it more intense and most likely at the moment of peak bad news flow and anxiety, you sell it only to spectacularly strike the bottom from which it recovers. We have all done it as investors – we learn from it and try to be more decisive in the future, whilst applying the psychological approach above so that we do not get hustled by the market again.
Unfortunately, I fear the ECB has been spooked by just such a phenomena in relation to quantitative easing. The US, UK and Japan launched their QE programmes several years ago as they foresaw that a lack of liquidity was restraining growth and could lead to deflation. Europe has only just commenced after many months of indecision in the face of German opposition. There are already signs of growth emerging which would have occurred anyway as the numbers relate to periods prior to launch.
It is becoming possible that, having put off the launch of the programme for so long and tinkering with bank regulation and ECB deposit rates just as they have pushed the nuclear liquidity button, the time when it was needed most has passed and it is now ill-advised. We should remember that part of the reason was to combat deflation but also to provide a security blanket if Greece defaults – , now potentially a much bigger issue than if it had been dealt with properly when it first reared its head three years ago.
The bond markets in Europe are starting to get the jitters that the ECB has overcooked the QE programme and will have to either reduce its size or its longevity or both. The reason for this is the breakeven rates on index-linked bonds which have picked up quite sharply since January as the oil price has started recovering. Two year inflation expectations in the US have risen from -0.16 to 1.6 as the oil price has rebounded and the same is happening in Europe. It has also not gone unnoticed that the oil price falls will begin dropping out of the year-on-year CPI comparisons from the end of July and so headline inflation is guaranteed to rise. Whilst we all know this, it could be argued that their procrastination on Greece and the artificial deflationary effect of the oil price falls has alarmed the ECB into implementing QE, just as global inflation is beginning to rise once more.
The worry is that if we get further moves in the breakeven inflation rate on index-linked bonds, further evidence of a tightening employment market through wage inflation and the slightest hint from the ECB that they are going to reduce their QE programme, investors will also panic and we will have a repeat of the ‘taper-tantrum’ of 2013. Being short of bonds, as we are, is at last starting to look like a very good place to be.