Bond markets are awash with rumor and uncertainty as they wait to see what central banks will do next. With the European Central Bank (ECB) having bought around €350bn of European corporate loans over the last year[1] and the Bank of England £10bn over the last six months, on top of vast government-bond purchases, markets are hanging on policymakers’ every word. With very little room for error in bond markets, any policy misstep or change in policy wind could leave bond investors nursing their wounds. As U.S. Federal Reserve Chair Janet Yellen, ECB President Mario Draghi and other central bankers attend the Economic Policy Symposium at Jackson Hole this week, many will be looking for indications as to how the grand experiment in quantitative easing might come to an end.

But while central-bank support may have been helping to keep bond markets from selling off, as there is a forced buyer, the real question for investors is whether they are being rewarded for the risk of the corporate outlook deteriorating or the policy direction changing.

The beauty of multi-asset investing is often considered to be diversification, as owning different asset classes with uncorrelated returns should help to reduce the overall volatility of returns over time. However, the real advantage in our view is being able to determine the potential risk and returns available in different asset classes and geographies. We contend that multi-asset investing is as much about what you don’t own as what you do, and at times there is just nothing to get excited about in some areas.

In the years since the 2008 financial crisis, authorities have engaged in ever-greater policy intervention to shore up economic growth. However, as our ‘state intervention’ theme identifies, policies such as quantitative easing and ultra-low interest rates have had unintended consequences such as inflated asset prices and misallocation of capital.

We have previously discussed the significant issuance of corporate debt to undertake share buybacks and the risks that this poses to balance-sheet strength, and our ‘debt burden’ theme encapsulates the sheer scale of the global debt problem, with total debt outstanding still greater today than it was before the financial crisis.[2] Given the low cost of financing debt, it is not surprising that debt has continued to increase.

As central banks have purchased huge swathes of bond markets, with the ECB alone buying €1.5 trillion in government bonds[3] in addition to the aforementioned €350bn in corporate loans, it is logical that bond yields have trended lower too. As shown below, the yield on outstanding investment-grade debt is at all-time lows, with investment-grade bonds in the UK yielding just 2% and those in the U.S. 3.1%.

Yields to maturity (returns in bond markets for a buy-and-hold investor) are at all-time lows:

MuchAdoUSchart1

The story is worse in Europe, with 70% of the European investment-grade bond market yielding less than 1%, and 93% yielding less than 2%.[4] This is less than the inflation rate that central banks are currently targeting, and there is much talk of moving this target higher.

In addition, investment-grade spreads (the difference between the yield on an investment-grade bond versus a similar-maturity government bond) are at the lowest they’ve been in a decade, as highlighted below.

MuchAdoUSchart2

At the same time, duration (a bond’s sensitivity to interest-rate movements) has increased, meaning investors are now more sensitive to changes in the yield (in either direction).

MuchAdoUSchart3

Today investors in investment-grade bonds receive a lower return and have to take higher interest-rate risk than at any time in the last two decades. In fact it would take less than a 0.3% rise in the yield to wipe out any total return received over a year in the European or U.S. investment-grade bond markets, leaving very little room for error.

This is why our Multi-Asset Diversified Return strategy currently has the lowest weight to bond duration in its 14-year history.[5] While many are talking about “cash being trash”, in my view investment-grade bonds overall as an asset class offer little more to investors, and given the yields available in bond markets the opportunity cost of holding cash has never been lower.

Of course, it is still possible to find opportunities in select corporate bonds in areas where there is thematic support. Furthermore, shorter-dated bonds offer less duration risk and can provide a pickup versus cash. However, taking investment-grade bonds as a whole, in my view it is highly likely that another asset class, in some part of the world, at some point over the next five years, will offer better prospects than can be achieved in the investment-grade bond market today.

While some investors may want to play until the music stops, as Balthasar in Shakespeare’s play once said, the corporate bond markets appear to be highlighting “There’s not a note of mine that’s worth the noting”.

 

[1] The figure includes securities purchased via the CSPP (corporate sector purchase program), ABSPP (asset-backed securities purchase program) and CBPP3 (covered bond purchase program). https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html

[2] Institute of International Finance, Global Debt Monitor – June 2017. https://www.iif.com/publication/global-debt-monitor/global-debt-monitor-june-2017

[3] Via the public sector purchase program (PSPP). https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html

[4] Source: Bloomberg, August 2017.

[5] Positioning as at August 23, 2017.

This is a financial promotion. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.

Important information

This is a financial promotion. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.

‘Newton’ and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited and Newton Investment Management (North America) Limited (NIMNA Ltd). In the UK, NIMNA Ltd is authorized and regulated by the Financial Conduct Authority in the conduct of investment business and is a wholly owned subsidiary of The Bank of New York Mellon Corporation. Registered in England no. 2675952. NIMNA Ltd is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. NIMNA Ltd’s investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request.

Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including NIMNA Ltd.

Certain information contained herein is based on outside sources believed to be reliable, but their accuracy is not guaranteed. Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2006 The Bank of New York Company, Inc. All rights reserved.

Share