The three weeks following the ECB’s announcement it was expanding its asset purchase programme managed to turn flows into fixed income on their head. While doubts remain about the impact of the move on the real economy, most agree corporate bonds are set to be the big winner from the ECB action. Compared with outflows of €24.4bn (£19.3bn) in January and February, fixed income funds saw inflows of €11.6bn in March, data from Morningstar reveals.
“Even after these long years of the ECB taking extraordinary measures, they seem to be able to change the direction of flows and investors coming back to the bond market,” says Matias Möttölä, EMEA manager for the Morningstar research team.
At the March meeting, ECB president Mario Draghi revealed the asset purchase program, which had previously been focused on government bonds, was being extended to corporate bonds, albeit excluding banks. The programme would also be expanded by a third from €60bn a month to €80bn.
To provide some sense of scale, net assets in the European corporate bond category sat at €123bn in March, following €3bn of inflows for the month, compared to outflows of €869m for the year to date.
Prices, trickle-down effects and fundamentals, are all reasons to take interest in fixed income assets at the moment says Vasiliki Pachatouridi, iShares fixed income strategist at BlackRock. She says the price of investment grade industrials and utilities issued in Europe are likely to rise, due to “another buyer further down the line”.
Secondly, she adds, other corporate debt sectors beyond European investment grade are likely to rise as well. “If Mr Draghi is looking to include BBB bonds and above, investors who are naturally buyers of credit or who want to put yield in their portfolio, are likely to go further out in the risk curve or look at other geographies such as US corporate debt.”
Finally, Pachatouridi adds that iShares is “quite constructive” on corporate bond fundamentals currently. This was due to investors overestimating the risk of default, as well as rising demand for income generating assets, particularly in Europe.
In April, Draghi drip-fed a few more details about the corporate bonds eligible for the asset purchasing programme, specifying that it would cover a maturity range from six months to 30 years, and could include senior insurance bonds, cross-over credits and bonds from corporates that are established in the euro area even if their ultimate parent is not in the euro area. The central bank would buy up to 70 per cent of the outstanding total of any eligible bond.
With this information you can make some general calls, says Chris Mayo, investment director at Wellian Investments. “When you look at the universe, taking out all the banks, what you’re left with is France, Netherlands and then Germany are the biggest country profiles, and utilities is the biggest sector.”
Bryn Jones, head of fixed income and fund manager for the Rathbones Ethical Bond fund, describes the ECB’s action as an “aggressive programme and has sent spreads romping in tighter”, though he warns small investors may be pushed into riskier assets.
“Ahead of the meeting we were extremely long subordinated insurance with the view the ECB would be stepping in and buying senior insurance. As a result of that you get crowding out of the market, over the 12, 18 months, they’ll go out and they’ll be buying senior insurance paper which will pushing yields down and pushing out traditional investors, which will be more likely to be coming into the sub insurance space and causing spreads to contract there, which is where we’ve got a big overweight.”
However, there is caution about the asset purchasing programme’s effects too. David Stanley, portfolio manager of the T Rowe Price Euro Corporate Bond fund, says supply has already got worse as investors scramble to purchase before the ECB. “More concerning are the market distortions caused by the outperformance of eligible bonds as value relative to fundamentals is getting stretched. If this trend continues, investors may need to question whether they are being compensated for risks.”
Stanley says active managers could be considering credit exposure in credit default swaps, rather than “squeezed” cash bonds, or increasing exposure to euro-denominated corporates domiciled outside Europe where spreads are higher relative to fundamentals.
Whether the opportunities in the category will continue remain to be seen. Möttölä warns large inflows could be temporary. “The last month when we had large inflows was in the beginning of 2015 and that was when the ECB announced their earlier programme to buy sovereign and quasi sovereign bonds. Since that month, fixed income has been on the losing side. So these are obviously two different announcements and it’s hard to exactly forecast what will happen but at least in 2015 the turn into fixed income funds was really temporary.”
However, those in fixed income argue there will be a longer impact. “If you look at the path of other central banks in terms of QE programmes it certainly takes a number of years to implement the programme but also reduce it and eventually exit it. It’s not something they do for a month, two months, six months, and then they suddenly stop,” says Pachatouridi. While the ECB remains in the market supply and demand dynamics will be impacted, says Jones, which at current estimates is easily around two or three years.
Investors looking to benefit should look to funds with at least 15 per cent exposure to European corporate bonds, says Darius McDermott, managing director at Chelsea Financial Services. “It’s difficult to be hugely positive on the asset class, but I think the asset buying does give support over the next 12 months.” Among his picks are M&G funds, namely the Corporate Bond and Optimal Income funds, Invesco Perpetual’s Corporate Bond and Monthly Income Plus funds, as well as the Fidelity Strategic Bond and Jupiter Strategic Bond funds.
Investors have recently favoured passive strategies in European fixed income, with index funds only seeing one month of outflows in the past 12 months, compared to eight months of outflows in non-index funds. Pachatouridi says a strategy that takes a broad view on fixed income makes sense based on current information released by the ECB.
“With regards to how to ‘play’ the ECB, we did say the ECB announcement provides support for European credit and therefore investors are seeking to access that asset class. What that means is they’re taking a view on the asset class as a whole as opposed to single name bonds. If that is the strategy to take a view on the asset class, then an ETF or an index tracker is potentially a suitable vehicle to do this because you’re not trying to outperform a name, but you’re seeking to get access to an asset class.” She says ETFs that track European corporate bonds ex-financials could benefit from the ECB action.
Investors favoured large funds when they entered European corporate bonds and European high yield in March, according to Morningstar data. The Schroder ISF Euro Corporate Bond fund, the largest in the category with €6.7bn, saw the largest inflows for the month, with €490.3m. The next largest inflows were €179.2m to the Axa WF Euro Credit Plus fund. On the high-yield side the Pioneer Funds Euro High Yield fund topped inflows with €347m, ending the month with €1.6bn assets, followed by Candriam Bonds Euro High Yield fund, which saw €315.8m inflows and assets of €1.9bn.
But while fixed income specialists may be excited by Draghi’s stimulus, multi-asset manager Eric Lonergan, manager of the M&G Episode Defensive fund and co-manager of the M&G Episode Macro and the M&G Episode Growth funds, feels the move is somewhat inconsequential to someone taking a macro view.
“When you’re testing the success of a policy like that you want to see some impact in the specific assets you’re looking at, but you also want to see that transmitting to a macroeconomic effect. I think what’s clear is the macroeconomic effects of it are most likely trivial.”
Lonergan is favourable towards European high yield within corporate bonds, but sees much more value in equity. “The differential in yield between parts of the equity market and cash and bond rates are extreme.”
Möttölä says it’s a sentiment that’s being shared by other investors in the market. “The reality is we’re in an era where interest rates are extremely low and current yields plus expected returns on most fixed incomes investments are historically low. For long-term investors it’s not a surprise that people have been going elsewhere to find alternatives to fixed incomes.”