Volatility – Feature
at times like these it’s even more important to take a long-term view and look for asset classes that offer future gains,” he says. “For example, investment-grade sterling corporate bonds have become more attractive, with yields well above 6%.” And Fawcett notes that when inflation falls, these bonds are likely to be perceived as a good buying level, not least because even if the UK economy goes into recession, defaults by invest- ment-grade issuers are rare.
“International companies also choose to issue sterling-denom- inated debt so you are not necessarily buying UK economic risk when you buy a GBP-denominated corporate bond and ad- ditionally you are adding geographical diversification to your portfolio,” he says.
Going global
This being the case, there are other issues to consider, as bond investors face many important portfolio construction choices: government bonds are often the starting place, but even then, one faces the question of how much duration to hold, and whether to invest in conventional or index-linked bonds. “Investors are increasingly looking globally when it comes to their high-quality corporate bond portfolios, mixing exposure to the US, Europe as well as the UK, and moving away from traditional ‘all stocks’ portfolios to think more carefully about duration, often opting for shorter-dated bonds with less inter- est rate risk,” Mikulskis says.
“On that same theme, floating-rate paper has also been popu- lar in a rising interest-rate environment with things like asset- backed securities offering good returns often at a slight premium to corporate bonds of comparable quality,” he adds. It is also worth remembering that bond indices are not con- structed in the same way as equity indices, as the weighting of capital to individual issuers is affected by the amount of debt being issued, not just market prices.
This makes those indices less useful as capital allocation guides, compared to stock market indices which embed the market’s aggregate views and, therefore, carries a lot of information. “This has significant consequences, it means that investors might want to take more direct control over some of their cap- ital allocation decisions when investing in bonds, rather than using indices to guide their choices as is more common in stock markets,” Mikulskis says. The fixed income investment team of Mark Nash, Huw Davies and James Novotny at Jupiter Asset Management offer a guide- line about the nature of attractive government bonds across different nations. “A dividing line between sovereign bond markets with natural resources and those without is being drawn, blurring the previous ‘developed’ and ‘emerging’ mar- ket classifications,” they note, observing the impact of the ener- gy crisis on the bond picture.
These criteria present a potentially interesting list of countries which could be favourable to buy sovereign bonds: the US, Russia, Saudi Arabia and China, being top of the list. Investors could potentially be interested in the Russian 10-year sovereign bond, which yields 9.7%, except sanctions restrict them.
High quality
Despite, or even because of the market crisis, bonds will continue to play a role in a long-term portfolio, particularly for pension funds. “At Nest we believe having high-quality active management of credit portfolios is important, even when mar- kets are not fluctuating,” Fawcett says. And with the Bank of England confirming it is to push ahead with its quantitative tightening from 1 November, bonds can definitely be said to be back again. Bond sales this year, the Bank of England noted, will be in short and medium maturity, that is, bonds up to 20 years. It could also help deal with the scourge of rising inflation, which hit 10.1% for September. Reflecting on the recent crisis, for Jeremy Lawson, chief econ- omist and head of research at abrdn, the market chaos was, in fact, no bad thing. “The episode demonstrates there are still some self-corrective political and market mechanisms in place when truly bad fiscal decisions are made,” he says. On this reading, which we can describe as a mainstream mar- ket one, we may have much to thank the so-called bond vigilan- tes for, which were in effect pension funds. And looking ahead, Lawson adds: “The bond and currency markets may have set- tled for now, but the political volatility has much further to run.” In short, be aware, the volatility may not have completely left us.
We believe at times like these it’s even more important to take a long- term view and look for asset classes that offer future gains.
Mark Fawcett, Nest
Issue 118 | November 2022 | portfolio institutional | 27
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