Thursday 28 Mar 2024
By
main news image

The global bond market has seen high levels of volatility in the last few months, but the experts at Amundi Asset Management see upside to the situation and recommend coping strategies for investors.

 

THE global bond market has seen unprecedented movements in recent months. From the negative yields of European bonds, owing to the quantitative easing measures put in place in the first quarter of the year, to the sudden upswing in US Treasury bond and German government bund yields in June, future trends will be unpredictable and volatility unavoidable. 

Bond markets have been hit by high levels of volatility over the last six weeks, especially in the eurozone, according to Adrian Bender, head of product specialists, global fixed income, global macro and foreign exchange (FX) at Amundi Asset Management in London. 

He observed two distinct movements. “The 10-year German Bund, for example, touched a low yield of five basis points (bps) in the third week of April before surging to 80bps in the second week of May. Yields then fell to about 50bps when the European Central Bank (ECB) intimated that the summer’s quantitative easing purchases would be brought forward.

“The second movement was witnessed at the beginning of June when bunds rose above 1%, driven by higher inflation figures in Germany, but mainly due to comments by the ECB president that markets would ‘have to expect episodes of higher volatility’.”

Bender reckons that this movement is being driven by both technical and fundamental reasons. After an initial rise in yields in April — driven by rising oil prices, higher inflation expectations, comments by prominent US investors, improvements in eurozone macro data and profit-taking on rich valuations — there was significant short-term covering from highly leveraged hedge funds, which worsened the movement and kept liquidity poor.

“Given the return of two-way trades in the bond market, and against a backdrop of nearing US rate hikes and low liquidity, we expect sovereign bond markets to remain volatile in the near future, with periods of over and undershoot,” Bender says.

The effects of the bond market environment has spilled over into other asset classes. The biggest impact has been on the FX markets.

“The yields are so low and there are currency wars going on. There is a corollary effect on currencies when countries target interest rates,” says Raymond Lim, director and head of Asian bonds at Amundi Singapore Ltd. “From a bond investor point of view, currency becomes a more important asset class than just yields.”

Amid such swings and negative yields in this environment, Bender advises investors to adopt a change in mindset when it comes to bond yields. They should either lower their expectations or be prepared to change strategies to generate more alpha — a risk-adjusted measure of the active return on investment — in their portfolio, he says.

“The average expectation for bond [yields] in Europe is 4.5%. The problem is you have 7% [of bonds] giving you a negative [return], and the next 50% giving you less than 1%. The yield to maturity of the global aggregate benchmark is now about 1.4%,” Bender tells Personal Wealth in an interview before a recent investor briefing on the outlook for fixed income market. 

“But if your expectations are 4.5% [returns], you have to do things differently. You can’t just sit back, hold and hope for a high carry like you did a few years ago.”

Investors who are not willing to lower their expectations will have to generate more alpha elsewhere. As alpha comes from capital gains, Bender advises investors to look at other asset classes and venture away from the traditional buy-and-hold bond portfolio. 

“Go towards more relative value trading strategy between countries, moving into high-yield investments, looking at emerging market debt and foreign currencies. If you want to generate enough alpha to compensate for the lack of positive carry, you have to do things differently. The main thing is for investors to change their mindsets, induced by these low or negative yields,” he says.

Asia still has potential for growth

While the US and European bond markets are expected to continue seeing volatility, investors can explore the growth potential in Asia, says Lim. Asian countries have the ability to generate domestic demand even though the global growth environment is not conducive, he adds.

“However, a lot of that [domestic demand] needs to come through reforms and we see several countries doing that. China has a major reform pipeline — its plan is clear, precise and within our expectations. 

“In the next two or three years, the capital account in China will be open, so capital inflows and outflows will be more free. This will open up the country’s services sector.”

He also has his eye on Indonesia and India, especially with Prime Minister Narendra Modi promoting India as a manufacturing hub. Lim reckons that investors should hold more intra-regional investments, as Asia has been funded by self-created capital.

“At this point, capital is still flowing into Asia, which creates some of the volatility that we see affecting the region. However, once we move away from that and create our own demand and capital, we should be able to isolate and insulate ourselves,” he says.

Even if Asia went through a taper tantrum, the region is in a better position to withstand the turmoil today, says Lim. This is despite Indonesia and India being a part of the “Fragile Five” — a term that was coined in 2013 to describe the two countries, Brazil, Turkey and South Africa as emerging economies that are too dependent on foreign investment to finance growth. 

“Asia is in a better position today, especially Indonesia and India, which are a lot stronger. Strong leadership is in place and the economies are a lot better now,” he says. 

“In terms of monetary policy, Asia is at the stage where it is easing [measures]. We saw it start in January when there were a lot of surprise [interest rate] cuts. Indonesia and China had one, India had a few.

Even Singapore was cutting, and some countries can still cut some more.”

Lim expects to see rate cuts in Thailand and South Korea, while China and India at this point have the highest potential for multiple cuts this year. Investors who are banking on high yields in a low volatility can still get that in Asia, particularly from China and India, he adds.

“China has room for more rate cuts. The central bank cut its reserve requirement ratio (RRR) to 18.5% in April. It can easily move down to 12% and there’s another 6.5% of RRR cuts that we can expect. For India, we are expecting 100bps to 150bps in interest rate cuts over the next two years,” he says.

“For both countries, the yields are still fairly high. China is 3.5% to 4% at the long end, while India is much higher at 7% to 8%. Between these two, the potential for capital gains as well as carry is there. On the other side of volatility, these two are closed markets, so they are not very affected by global capital flows. The current accounts and balance of payments are fairly strong, so they can withstand volatility in the market and offer good returns at the same time.”

 


This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on June 22 - 28, 2015.

 

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.

      Print
      Text Size
      Share