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’.
He argues: ‘With inflation well contained in most of the major markets, today presents an opportune time to begin building inflation hedges, with markets pricing a subdued outlook. These bonds can also be a useful tool to mitigate against the risk of rising rates.’
Finally, he opts for another often overlooked part of the market: Chinese renminbi-denominated debt, also known as dim sum bonds. ‘This asset class has annualised volatility of around 3%, which is around a third of that experienced in emerging market local currency bond indices, but offers yields in excess of 4%,’ he said.
‘This is an attractive proposition given its modest investment grade credit risk, low interest rate duration and potential to capitalise on a modest upward appreciation of the Chinese currency. Dim sum bonds proved much more resilient through the summer of this year and we expect another steady performance from these bonds in 2014, especially in light of recent reform announcements.’
Thomas Becket, Psigma Investment Management’s chief investment officer, takes a more broadly positive position on Asian fixed income, tipping the Aberdeen Asian Local Currency Short Duration Bond fund in particular.
‘There have been two things to avoid in 2013: sovereign bonds and emerging market currencies. The fund invests in both and produced a mildly negative return last year. However, we believe that the future might be better and now could be the time to back emerging market currencies,’ he said.
‘There is extreme negativity around the short term outlook for emerging market FX, but with many of the Asian economies stabilising we expect better performance in 2014. Given the strength that the pound has enjoyed in recent months there are reasons to expect some of the shine to come off sterling this year, particularly if investors worry about the fact that consumption through debt creation is the primary driver for the UK economy. Asian economies do not have that problem and will surely gain against the pound over the coming years.’
A naysayer on this point, though, is Jim Leaviss, M&G’s head of retail fixed interest.
‘We think that regardless of which reform path Beijing takes, more corporate defaults, rising non-performing loans, and some degree of a credit crunch are unavoidable over the next three years.’ He adds that this could provoke a depreciation of up to 10% depreciation in Asian currencies.
He suggests Brazil, for example, where the bond market has corrected by 3-5 percentage points and now offers ‘outstanding’ 12-13% yields.
For those preferring less exotic fixed income allocations, Leaviss said straightforward corporate bonds will produce reasonable risk-adjusted returns in 2014.
‘With growth in the developed world recovering, defaults are likely to stay low.’ However, he urges investors to focus on quality, particularly given the resurgence of covenant-light paper and payment-in-kind bonds.
‘It is more important than ever for bond investors and their credit analyst teams to do their homework,’ he added.