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Ignis's Bowie: how to tackle the low yield conundrum

on Nov 14, 2012 at 14:07

Ignis's Bowie: how to tackle the low yield conundrum

AA-rated Chris Bowie, manager of the Ignis Corporate Bond fund, explains where he is turning to in the hunt for income.

He writes:

Sovereign bond yields are close to all-time lows, debt to GDP ratios are looking stretched on any historical basis and the US and UK are printing record amounts of money. 

With history not favouring fixed income investors when money is being printed and the stock of government debt excessive, the key question now is why should any risk-averse investor buy bonds with such a low level of absolute yield?

The question is valid. For credit specifically, my return projections for the next 12 months look extremely modest. The average yield on European corporate bonds is 2.4%, and investment grade credit is unlikely to beat this.

The reason I believe overall corporate bond yields will not fall, and therefore not generate capital gains, is that while spreads are relatively attractive, government bond yields are not fully compensating for the headwinds facing fixed income over the next few years.

 One of the main risks is that the monetary experiments being conducted in the US and the UK in the form of quantitative easing (QE) are relatively unproven, and in my view increase the likelihood of future inflation.

Of course timing is key, and in the near term there are equally large risks of wage deflation and balance sheet deleveraging at the consumer, corporate and government level, all leading to generalised price declines. These forces will likely keep a lid on inflation in the near term. But at what point will printing money lead to a generalised price rise?

QE and inflation

This is a difficult question to answer and one I cannot predict with any certainty. History can, however, often help make informed choices about the future and it teaches that printing money often leads to inflation.

Japan is the possible exception but electorates in the West are unlikely to accept two decades of lost potential output and employment – and that is why ultimately I think inflation is a more likely outcome. Contrasting this view of the risks of rising sovereign bond yields, I am relatively bullish on certain credit sectors, such as corporate hybrids.

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