He adds that fixed income has “done its job”, but questions whether this will remain the case. “Coupon levels have fallen considerably, while lower bond yields could have an impact on downside risk management.
“Diversification is still there, but this has not always been the case. August 2015 was a good example, when fears over China gripped global markets. At a time when equity markets were hammered, bond yields also spiked. The real pain point in markets is when fixed income stops behaving the way it should.”
Correlated assets
Many analysts have said fixed income securities are becoming more closely correlated with each other, but is this really the case?
Gareth Isaac, senior fixed income fund manager at Schroders, says, “I think correlation across asset classes has gradually been increasing since the financial crisis. It’s a function of a number of factors, and one of the major factors is liquidity within the system. What we are seeing is risk assets as a whole – equities, high yields, investment grade bonds or emerging markets – in periods of risk-on, and even the spreads of those tend to widen out because there is a lack of liquidity in the market.”
“With gilts it is slightly different. Apart from the ‘taper tantrum’ back in August 2013, you still have a good offset in buying duration for a risk-off event. But I think with the level of yields where they are, you don’t get the full protection that you would have done pre-crisis.”
However, Jon Cunliffe, chief investment officer at Charles Stanley does not entirely agree that bonds are becoming more correlated. “I think it’s perfectly possible to imagine a world where high yield bonds do quite well whereas sovereign bonds – particularly short- to medium-dated maturities – don’t do so well.
“That might be in an environment where growth is reasonably solid and policy normalisation takes place via higher short rates. It’s perfectly possible to imagine high yield performing like a pro-risk asset.”
“I think there are different uses for fixed income in the context of a balanced portfolio that has exposure to a number of asset classes,” he says.
Attractive investments
According to Mr Isaac, US dollar-denominated emerging market bonds look attractive. He says this is because “Countries like Brazil, Mexico and Argentina are looking interesting”.
“Brazil looks particularly attractive because there is a temporary new leader. While the economy is in a poor state, it is showing signs that it has bottomed out and it is going to improve. But we are not investors at the moment.”
