In February, a surge in inflation expectations in the context of strong global growth, combined with central banks hinting at upcoming additional rate rises caused a spike in government bond yields globally. To illustrate this, the below table highlights where US, German and UK ten-year yields are now, compared to the end of 2017.
Source: Bloomberg, as at 23/02/18.
Understandably, this has caused a sell-off within fixed income as an asset class, with many commentators now speculating that we are finally at the end of a long bull market in bonds. This speculation is to be expected, as we are all aware that we are entering a period of rising interest rates, following a decade in which they have been at rock bottom. However, it has ignored some subtle but important points.
Cross asset volatility & shifting opportunities
Fixed income markets have been volatile, but they have actually held up better than equities. As an example, since the end of January global equities have fallen by more than 4% in local currency terms. Global bonds are down just 0.8% (as at 23/02/18). This has been due to concerns over the pressure rising rates may put on highly-valued growth stocks, alongside uncertainty surrounding the inflation outlook, despite the synchronised global economic recovery that we have been witnessing.
In addition, rising yields change the investment paradigm somewhat. To utilise an example from the US, 2-year treasuries now yield more than the dividends received on the S&P 500 Index, which suddenly makes them a more attractive investment proposal in the eyes of many market participants. Would they prefer the ultimate risk-free asset with a 2% yield, or a potentially volatile ride in an expensive equity market?
2 year treasury yield versus S&P 500 dividend yield
Source: Bloomberg, as at 15/02/18.
The need for diversification
As a result, there is still a significant demand for fixed income assets, even within a rising-rate environment. A demand that we believe is healthy and which should continue to support the asset class, regardless of the underlying environment. However diversification remains important within each asset class held in a portfolio. As active managers we seek to add value in a number of ways, identifying themes across:
Allocating to either government bonds or investment grade credits
Taking a view on currencies
Which sectors offer the best value
Identifying yield curve opportunities
Bottom-up stock selection
We do this through a top-down approach to setting interest rate and macro forecasts and a bottom-up approach to setting credit exposures. For example, during the recent market-sell off, corporate bonds have outperformed their government counterparts and our overweight here has been beneficial, as has our exposure to the Eurozone. In this low-but-rising rate environment, holding the appropriate mix of currencies is essential as it can substantially add to total return, which is at the heart of our current strategy. We believe this highlights how a diversified, actively managed global bond portfolio can add value in all market environments.
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. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail 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 should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. 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.
Data Source – © 2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
The Canada Life Investments blog page features images licensed from Getty Images International. These images shall not be downloaded, republished, retransmitted, reproduced or otherwise used in any way. Aside from the above, and unless otherwise stated, Canada Life retains copyright in and/or has a right to use all contents of this website (including text and graphics) and such contents shall not be copied, distributed, extracted or modified without the express prior written consent of Canada Life unless for private, non-commercial use.
CLI01116 Expiry 23 February 2019