With turbulence hitting equity and property markets, and interest rates on a downward curve, investors are waking up to the attractions of fixed-interest investments. Graham Bentley, head of investment marketing at Skandia UK, reports that Skandia’s fund platform in January saw high demand from private investors for fixed-interest investments and comments, ‘Market volatility seems to have resulted in a reduced appetite for risk. Half of the ten top-selling funds over the month were fixed interest, with M&G High Interest topping the table.’

John Stopford, head of fixed income at Investec Asset Management, argues that ‘The recent turmoil in financial markets has not been confined to equities. Bond market volatility has jumped to the highest level since the LTCM crisis of 1998. US government bonds, in particular, have rallied sharply and credit markets have sold off in response to signs of slowing growth and increasing stress in the financial system.’

He adds, ‘US policymakers have signalled that they intend to do whatever it takes to avoid a protracted slowdown in growth. The Federal Reserve has cut interest rates by almost two percentage points in less than six months and is poised to cut them further. But with volatility comes opportunity.’

Stopford says that ‘In particular, US bonds look expensive. Ten-year treasury yields, adjusted for core inflation, are at multi-year lows, yielding about one per cent. These should sell off, even in a recession, especially as easier policy will cause the yield curve to steepen significantly. We see better value in other markets, especially European government bonds, or index-linked bonds on a relative basis, in an environment of rising food and energy prices, easier monetary policy and sticky core inflation.’

He adds, ‘Yield spreads on high-quality shorter-dated non-government paper are close to their cheapest levels of the past two decades and offer decent returns. Spreads on longer-dated and lower-quality issues are less compelling, being vulnerable to renewed weakness in the event of a recession, but this would present a good buying opportunity.’

Emerging opportunities
There is also an array of opportunities in emerging bond markets. Peter Eerdmans, of the Investec emerging markets debt team, points out, ‘As the markets priced in a larger chance of US recession, global equity markets continued their slide. Despite weakness in global equity markets, emerging market local currency bonds declined only marginally in the first half of the month and finished January in positive territory on the back of positive demand, decent economic growth and still-elevated commodity prices.’
Eerdmans concludes, ‘We expect local currency emerging market debt to see strong flows this year, as this investment class is “discovered” by more investors. The US$5 billion World Bank-sponsored fund will add to this.’

But he notes, ‘That said, given the global economic background, we expect volatility to remain high. We are likely to lighten up a bit further into strength,
and buy modestly on dips. Our overall positioning is quite neutral, but we have emphasised the theme of buying countries with strong economic resilience and selling those reliant on global capital. Our long positions in markets such as Brazil, Israel, Slovakia, Russia, the Philippines and Qatar versus our short positions in Hungary, South Africa, Korea and Romania fit this theme perfectly.’