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Agenda

Setting the investment agenda

20.01.2021

Agenda 2021 – Fixed Income


Tracey McNaughton

Chief Investment Officer 

Fixed income assets had a reasonable year in 2020. Bond yields tumbled and credit spreads tightened in response to the unprecedented monetary stimulus. Over the year interest rates were cut no less than 252 times from 94 central banks around the world. All but 17 of those cuts came from emerging or frontier markets. Argentina took the prize for the most number of rate cuts by a central bank with the count sitting at eight. Developed economies such as the US and Australia were responsible for just 7% of all rate cuts. This reflects the fact that developed markets came into the COVID-19 crisis with policy rates already at very low levels. Before 2020, 2019 stood out as the year with the greatest number of rate cuts since the GFC. 

The move lower in yield through the year now makes bonds an expensive asset class and at risk of a negative return. Low inflation and accommodative central banks should limit the rise in bond yields during the recovery but the low starting yield, particularly for government bonds, makes for a paper-thin income cushion to offset a potential negative capital return. 

Even credit is now looking expensive. The yield on US high yield is now below the two-decade average for investment grade.

Global indebtedness increased by $15 trillion in 2020 taking the total to $277 trillion. Governments accounted for 60% of that increase. Much of this increased debt has found its way into central bank balance sheets, blurring the boundaries between fiscal and monetary policy.

Not so high yield on high yield bonds (%)

Enlarge Source: Bloomberg

 

Portugal’s 10-year bond yield fell below 0% for the first time. Recall Portugal was the “P” in PIGS during the European debt crisis in 2012. Italy, Greece and Spain the other. Portugal’s debt is 137% of GDP.

 

In addition to the risk of a negative return, government bonds no longer offer the diversification or liquidity benefits they once did when yields were higher. The table shows how the diversification benefits of government bonds have decreased in time as yields have moved lower.

Enlarge Source: Bloomberg

Emerging markets (EM) have scope to reduce interest rates further, and any deterioration in the USdollar will favour local currency bond performance. Liquidity risk should be heeded, however, and active selection paramount.

All of Germany’s sovereign debt –typically considered the region’s safest asset – has a yield below zero, meaning investors lose money by holding it.

Share of global bonds comes with a yield less than...

Enlarge 
Source: Bloomberg

80% of global bonds now come with a yield less than 2%.

The issuance of green bonds is increasing but investors should beware. Green bonds are relatively illiquid yet for most investors they form part of the fixed income allocation. The illiquid nature of the bonds also makes them difficult to trade from a management perspective yet most investors pay active fees to participate in them.

Global green bond issuance (USD bn)

Enlarge Source:
Climate Bond Initiative 

 

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