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Can fixed income confound expectations in 2014?

by Robert St George on Jan 13, 2014 at 13:57

Can fixed income confound expectations in 2014?

It has been a tough year for bond investors, as Bill Gross will attest: his flagship £150 billion Pimco Total Return fund has just recorded its first annual loss since 1999.

And not many are expecting 2014 to deliver a fixed income rebound.

‘There are few bargains in fixed income markets,’ said Russ Koesterich, BlackRock’s global chief investment strategist, in a blunt outlook for the asset class.

One of last year’s most popular bond calls was simply to slash duration, but that may have run its course. Andrew Wells, global chief investment officer for fixed income at Fidelity, warns it is ‘by no means a panacea’ for two reasons.

‘Firstly, income is eroded, and secondly, the characteristics of a bond portfolio are changed, such that bonds lose their diversification benefits and exhibit more correlation to growth assets,’ he observed.

‘A low duration strategy also requires impeccable timing, as being persistently low duration incurs a cost on income that leads to consistent underperformance over the longer term.’

But there are parts of the market where Wells does see value. He highlights three areas.

His ‘standout’ pick is European high yield, where he feels the combination of higher average credit quality and lower interest rate risk is attractive.

Chris Iggo, chief investment officer for fixed income at AXA, agrees: ‘As long as the European Central Bank (ECB) is able to continue to supply adequate funding, it is hard to see a big sell off in bank or other European corporate debt.’

The second recommendation from Wells is inflation-linked bonds, a largely unpopular instrument as global inflation remains subdued but one he views principally as ‘an excellent diversifier and hedge against the policy unknowns’.

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