Inflation is on the rise
Since Donald Trump’s election as President of the United States in November last year, both interest rates and inflation have been trending upwards across the developed world. Recently, the US Federal Reserve (Fed) raised rates by a further 0.25%, whilst in the UK inflation came in at a higher-than-expected 2.9%. Typically, this environment is deemed to be detrimental to fixed income investors, given the pressure that higher rates puts on bond prices. However, we believe that a global, active approach can negate much of this risk, in particular when compared with passive strategies.
Active versus passive
Recent quantitative research undertaken by PIMCO highlights that more than half of US active bond mutual funds beat their median passive peers and benchmarks in most categories over the past 1, 3, 5, 7 and 10 years. A further study by Western Asset Management in the United States further validated that active managers have been able to achieve consistent outperformance in the global bond space over the last decade, when compared to the Barclays US Aggregate Index and equivalent passives. For example, as highlighted in the graph below, active managers have outperformed by 0.68% per year, over the last ten years.
Source: Western Asset White Paper “In Bonds, Active Beats Passive,” and eVestment, total return, gross of fees, as at 30/09/16.
The case for fixed income funds
Undeniably, the asset class has been on an incredible long-term bull run and many commentators are now questioning whether a significant correction is looming, particularly in certain sectors of the market. Our view is that fixed income instruments should still form a core part of investment portfolios, given the attractiveness of a regular income stream. However, we do believe that investors should take an active, global approach to the asset class, both to reduce risk and to aim to outperform the market. For example, corporates outperform government bonds in times of rising yields, whilst investing abroad allows you to benefit from currency movements.
Why international bonds?
Although government bond yields across developed markets are currently at historic lows, relatively low inflation and positive growth forecasts are supportive of corporate bonds, even in an environment of rising yields. In addition, yields are not rising uniformly across the world, the quantitative easing (QE) programme implemented by the European Central Bank (ECB) is pushing yields and spreads lower in Europe for example. Active managers also have the potential to earn additional returns from currency. For example, the Euro has appreciated by 2% YTD versus Sterling, which has benefitted our holdings in Euro-denominated bonds.
The underlying macro environment also gives rise to specific opportunities for global bond investors. For example:
Continued fiscal stimuli and tax cuts are good for business, therefore buy corporates over government bonds
Higher rates are good for banks and insurers, buy financials
Higher rates are also supportive of certain currencies, buy foreign-denominated bonds
Negative sentiment has dominated fixed income newsflow as, quite reasonably, investors are worried post such a long bull run. Indeed, benchmark and passive strategies may suffer in certain areas. However, we believe the ability of active investors such as ourselves to recognise supportive macro trends and then undertake the bottom-up work to identify individual securities leaves us well-placed to outperform. Historical studies have highlighted the ability of global bond investors to outperform the market, it is now our job to maintain that trend.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. The contents of this article are not intended as investment advice.
The information contained in this document is provided for use by institutional investors, professional investors and professional advisers and is not for onward distribution to, or to be relied upon by, private investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and are subject to change at any time without notice. The contents of this article are not intended as investment advice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.
CLI00819 Expiry on 16 June 2018