Fixed income managers explain their portfolio positioning following a volatile half year, and how they are taking advantage of opportunities in the sector while negotiating challenges including political uncertainty and 'lower for longer' bond yields.
Jasper van Ingen, senior portfolio manager, NN Global Convertible Opportunities fund
Secular trends
With inflation risk seemingly absent at the moment, we believe market risk to be the main source of risk applicable to bond investors.
To name a few potential headwinds that may surface: geopolitical risk, the risk of disappointing central bank action and a new fall in oil prices that could lead to further defaults in an already hard hit sector.
On a positive note though, we see continued opportunities for investors focusing on longer-term, secular trends.
An ageing population, healthcare spending, feeding the world, cloud computing and infrastructure spending are all investment themes that are highly likely to be valid and themes we are currently invested in via the NN Global Convertible Opportunities fund. Thematic investing does require investors to invest selectively, rather than passively.
We think the best way to deal with the risks mentioned above is to be aware of them, expect black swan-like events to happen, diversify across investment themes, be very mindful of liquidity, keep appropriate levels of cash and always be mindful of the potential downside risk on any particular investment.
We believe investors in convertible bonds are particularly well placed to navigate uncertainties by the defensive nature of the asset class and strong credit selection of our fund, in addition to being well positioned to participate in the upside of companies that fare well on the back of long-term trends and themes.
Alexis Gray, economist - Europe, Vanguard
Timing difficult
Fixed income investors face some difficult choices. In our view, the simplest solution might be the best. The challenge is widely acknowledged: yields are at epochal lows and are unlikely to rise any time soon.
Investors can take on more risk. They can play the market to time duration. They can give up on bonds altogether. But this approach may not deliver the required outcome.
Taking on too much additional risk, for example by investing in high yield bonds, in many respects defeats the purpose of a fixed income allocation. You may get the income you want, but nothing is free.
High yield bonds historically have equity-like risk. Abandoning fixed income gives up a stable income stream, however low, and a buffer against falling equity markets.
And timing duration is not easy either. Many investors have discovered this to their detriment in recent years. Year after year, commentators have predicted a rise in yields, and year after year they have been wrong.
Is there an alternative to reaching for yield by taking more risk? We believe there is, by better maximising the available opportunities in a low yield environment. So how?
Step one, invest in a globally diversified portfolio. The world is far from globalised so yields are neither uniform nor moving in lockstep. Take advantage of difference. Step two, target total return instead of natural yield, focusing on value rather than units.
Step three, go low cost, preserving as much of your yield as possible.
Mark Holman, CEO and manager, TwentyFour Global Unconstrained Bond fund
Balanced portfolio
The biggest risk is that the ramifications of Brexit are not yet clear in the UK (or Europe); the negotiation process has not begun, there are still a lot of unanswered questions and several European countries are due to hold elections next year - all of which will result in volatile markets.
In addition, Italy is due to have a referendum on important constitutional issues in October and Matteo Renzi has already said he would leave if the result is adverse.
However, we believe credit spreads will continue to be supported by the ECB's Asset Purchase Programme and although some European Banks have earnings issues, from a fixed income standpoint, they remain well capitalised with good credit quality.
In our opinion, certain bonds in the banking sector look cheap, along with the ABS sector (CLOs in particular) - but being selective is extremely important.
Going into H2, our unconstrained portfolios are more balanced and we have increased our gilt position and cash bucket.
We have a suite of hedges (eg, the crossover) to protect our portfolios through times when the market is looking for risk-off products, and this should help dampen volatility.
However, we have high conviction on the individual bonds that we hold and this gives us comfort that we can continue to outperform in the medium term.
