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In its outlook for the third quarter of this year, Robeco’s Global Fixed Income Macro team shares its views on Treasuries, credits and emerging debt and explains its positions in Rorento Global Total Return Bond Fund.
The back-up in long-term German bond yields can be seen in the context of normalized inflation expectations for the region. The large-scale government bond purchases by the ECB and the increase in energy prices are behind this move. The significant yield curve re-steepening between 10-year and 30-year maturities is a reflection of the same investment theme. Within the portfolio we anticipated this move as we had exchanged our 30-year German bonds for 10-year bonds. This position has now been reversed again.
We find it hard to envisage a quick fix for the Greek situation. Neither do we expect a Grexit to take place in the short run. That leads us to predict a prolonged, protracted period of policy uncertainty. In this environment peripheral debt will find it hard to outperform. During April and May Rorento Global Total Return Bond Fund significantly reduced its exposure to these markets, well before the Greek government took everybody by surprise when it called out a referendum.
In our mind markets look complacent as to the likelihood of a first Fed rate hike later this year. Short-dated US Treasuries are therefore vulnerable to a surprise move by the central bank. Although inflationary pressures remain absent, labor market improvement would justify a very gradual policy rate normalization. Longer-dated bonds offer more value, especially compared with German Bunds or Japanese government bonds.
USD and EUR investment grade credits had negative excess returns versus government bonds over the first half of 2015. Subordinated bonds issued by financials and corporate high yield bonds were the positive exceptions. We stick with our preference for ‘sub financials’. The structural change the banking landscape is going through (more transparancy, less risk taking) is positive for bondholders.
Consistent, in-depth fundamental research on countries and companies is the backbone of our investment process. An important element in this analysis is the assessment of environmental, social and governance factors (ESG). We are convinced that integrating ESG factors into the investment process leads to better informed investment decisons.
Reminders of why investors should care about the social and governance fabric of a country are with us everyday. As clearcut as it may seem today not to invest in Greek government bonds, investors were quite keen to participate in the country’s bond auction about a year ago. The EUR 3 billion bond sale in April 2014 was oversubscribed by six times. Five-year bonds were issued at 4.95%; currently this bond trades at a price of 45 and a yield above 20%.
The lack of convincing improvement in the ESG profile was one of the factors that helped us not to return to the Greek bond market. The country’s governance woes were crystal clear, also in 2014. Rampant corruption, weak institutions, shaky political stability, and poor competitiveness hamper effective policy making, necessary reforms and ultimately, economic performance. Some of the large downside risks such as the strained relationship with international creditors, a widening funding gap, simmering social tensions, another early election, the implementation of capital controls, or even a possible ‘Grexit’ have since then materialized.
ESG integration also helps to highlight opportunities. Ireland stands out as a prime example of a country that has successfully introduced decisive reforms, markedly improving its ESG profile over recent years. The country’s stronger social fabric and governance profile have helped us early on to identify the investment opportunity in Irish government bonds. At 1 July, close to 4% of the Rorento Global Total Return Bond Fund is invested in Irish government bonds.
‘ESG integration helps to highlight both risks and opportunities’
For emerging economies, taking into account ESG profiles is at least just as relevant. As an example, in the summer of 2014, we considered investing in Brazilian local currency bonds. Interest rate yields of above 12% for short-dated bonds looked appealing. However, after thorough analysis we concluded the investment case lagged conviction.
Especially Brazil’s weak ESG profile triggered doubts. The corruption scandal at national oil giant Petrobas triggered renewed investor mistrust. Brazil suffers from rather poor government effectiveness, regulatory quality and lagging human development despite its recent progress in reducing poverty. Brazil’s higher risk, reflected in its lower ESG scores, was one of the factors keeping us away from Brazil last summer. This turned out to be a wise decision as markets became more uncomfortable with developments in Brazil, reflected in rising risk premia and a depreciating currency.