Fund managers remain upbeat on today’s bond market outlook despite current high volatility and outflows from funds, but the future for the asset class remains uncertain.
In the 10 weeks to 13 May this year, bond funds saw the largest outflows since 2013 with investors moving some $5.9bn (£3.7bn) out of global fixed income funds, according to data from Bank of America Merrill Lynch and Emerging Porfolio Fund Research.
More than $1.2bn came out of high grade credit funds over the same time period, which was the biggest outflow since the US bond buying programme in the summer of 2013, the research finds.
“It is increasingly difficult to justify the big outflows for bonds with yields going lower and lower,” says Old Multual Global Investors head of fixed income Christine Johnson.
She says: “Speaking with some prospective clients last week it was interesting to see their views that probably both bonds and equities are overvalued but at least with equities you got some chances of upsides.
“With bonds you got to the point where, how much lower can they go? Your potential for upside is extremely limited and your potential for downside is quite large.”
Schroders fixed income fund manager Gareth Isaac thinks the bond market sell-off has made a number of investors nervous, but this weakness should be viewed in the context of “an overextended rally”.
He says: “The most vertiginous rises in yields have been in Europe, where bond yields became detached from reality.”
The yield on a 10-year German government bond had fallen below 10 basis points in mid-April this year, and the yield on a 30-year Italian government bond was below 2 per cent.
However, bonds remain supported by a challenging income environment, in Isaac’s view, and the medium-term outlook for fixed income “still looks strong”.
Johnson says: “We are still very happy in short-dated high yield but it doesn’t mean you won’t see volatility, you will. Your risk is volatility but at least there is some reward. At least if you are getting paid 4, 5 or 6 per cent you have something on the other side that compensates you.”
Isaac is still positive on some areas of both the investment grade and high yield corporate bond markets, but urges investors to be very selective.
He says: ”We have seen a significant amount of new issuance over recent months and quarters. However, credit has performed very well during the government bond sell-off. If our assumption that the rise in government bond yields will slow is correct, corporate bonds can continue to do well.”
Johnson adds: “If you look at the valuations between the US and Europe over the last few years … in 2012 the spread in the Eurozone was as much as 100 basis points wider as opposed to the US. So what you had was a lot of money coming out of international buyers falling into Europe, because it looked very cheap.
“Now, you have a complete reverse case,” he says, where the Eurozone is ”looking very expensive, and that combined with yields, which are absolutely rock bottom lows. So what you’re seeing is quite a lot of people transferring out of Euro credit and back into dollars, which is what we’ve been doing.”
JP Morgan Asset Managemen global head of the multi-asset strategy team John Bilton also argues that it is not fair to compare today’s bond market volatility to the 2013 US taper tantrum.
“During the taper tantrum in May 2013, US 10-year yields jumped 100 basis points over seven weeks, implied volatility in German bunds doubled and European equities fell 11.4 per cent. Over April and May this year, US 10-year yields are up 65 basis points, bund volatility has almost trebled and European stocks are 8 per cent off their highs.”
Though there is a difference with the past couple of years, he acknowledges that the market narrative, especially in fixed income markets, is indeed entering “a new regime”.
Johnson adds: ”If you enjoyed a great ride over the last couple of years, you now either move into dollars or sterling, or you move out of the asset class, like into European equities, for example.”
Though she hasn’t seen any outflows in her funds, Johnson is trying to protect from the volatility by investing in the dollar five-year B and BB high-yield space, and in short-dated UK, which will get her “pretty much completely out of Europe”.
Johnson concludes: “If you see European spreads going outside the US spreads again like in 2012, that would be interesting and a potential buying opportunity, but we are not there yet.”
However, the Fed’s movements in the US are another upcoming disruptor to the market, she says.
”A US rate rise is disruptive, people worry about it but I think the Fed will be very slow and gradual in the rises. Whether or not they’d acknowledge the disruption in the market attributable to Greece is possible, but the next meeting should be much more optimistic than the last one and will show more positive data.”