Despite talk of negative yields it remains a good environment for bond investors as opportunities continue to arise, according to JP Morgan Asset Management’s Iain Stealey.
Stealey – who is international chief investment officer of fixed income at the asset manager and co-manages the JPM Global Bond Opportunities fund – explained that bond yields are low and going lower because of the shift in direction by central banks globally this year.
Indeed, central banks have begun or are considering cutting rates over concerns of a slowdown in global growth.
“Last year, the Fed was raising interest rates,” he said. “This year they’ll be cutting rates, and I think they will continue to do that.
“We’ve already had easing from Australia, New Zealand, and a lot of emerging markets, including Indonesia, South Africa, and South Korea,” added Stealey.
As rates go lower, there could be a potential for better capital gains than are on offer in other asset classes.
“Given it’s a 2 per cent [yield] on a 10-year US Treasury, you do have the opportunity for some capital gain if those yields go lower,” he said.
“For example, if you go from 2 per cent on a 10-year Treasury today to 1.5 per cent. A 50bps [basis points] move, 10 years of duration, you get a five per cent return.”
Source: St Louis Federal Reserve
As such, with growing investor concerns around the length of equity market bull run, more money could head to the bond sector, which will provide a boost to the asset class.
Yet, with the market cycle also moving towards the later stage, the fund manager said investors should place more importance on diversification.
Undoubtedly, there are pockets of opportunity for investors willing to seek them out.
“For example, if you look at something like the high-yield market in the US, this is obviously down-in-quality credit, which typically doesn’t do so well in a downturn,” said Stealey (pictured). “But at the moment the yield is 6 per cent—that’s not so bad when you consider what else there is in the world from a bondholder’s standpoint.” .jpg)
Indeed, high yield bonds have been a significant contributor to the performance of the JPM Global Bond Opportunities fund recently, where US high-yield makes up 13.8 per cent of the portfolio, although it has been reducing exposure more recently.
The spreads of high yield assets have tightened, the manager noted, as central banks have become more dovish and improvements on the trade front have developed.
Corporate investment grade debt also contributed to performance more recently as investors have piled into higher grade bonds in a search for yield resulting from negative rates in Europe.
While negative rates in Europe – and Germany, in particular – pose a challenge, Stealey said, investors should not write off the continent as a whole.
“Places like Portugal, Spain, and now Italy are coming into the mix, as people may be getting less concerned about their fiscal situation and focusing on the ECB [European Central Bank] coming into the market buying bonds,” he said.
As such, the manager has been adding more Spanish and Portuguese government bonds to the portfolio.
However, the JP Morgan manager said that for those with a greater risk appetite, there are aopportunities to be found in sovereign emerging market debt.
Emerging market debt has also benefited from a more dovish Fed, the manager noted.
“When you look at places like South Africa, Brazil, Indonesia, Mexico—you have got a decent real yield,” he said.
As such emerging market sovereign debt currently stands at 7 per cent, with local currency paper representing a further 6.9 per cent.
“So, if you think about it from a diversified standpoint, there’s a lot about the bond market which you could still argue is interesting,” he said.
“It’s just a question of what sort of bonds you buy,” the fixed income specialist said, “as there are a lot of negative-yielding bonds out there.
“Of course, I’d love to tell you that yields will be where they were at the beginning of the year, but unfortunately that’s the world we live in today”, he added.
Moreover, the bond specialist is not holding his breath for a repeat performance of the first half of the year.
“Let’s be realistic, the returns are probably not going to be as good in the second half of the year as they’ve been in the first half,” he said. “But I still think you can generate positive returns by buying fixed income.”
Stealey has managed the JPM Global Bond Opportunities fund with Bob Michele since January 2015. During this time the fund has made a total return of 16.20 per cent, against a 15.68 per cent gain for the average IA Sterling Strategic Bond peer and a 12.13 per cent return for the Bloomberg Barclays Multiverse Hedge GBP index.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
The £74.6m, four FE Crown-rated fund has an ongoing charges figure (OCF) of 0.65 per cent and a 3.11 per cent yield.