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Flexibility is important. Don't get tied down. Keep searching for attractive yields, be selective and make sure you are rewarded for the risk you take. That is the mantra for bond investors in 2016.
Will the US central bank, the Federal Reserve, make the mistake of raising interest rates too soon? This question – posed by Kommer van Trigt, head of Robeco’s Global Fixed Income Macro Team – is rather a paradox coming at the end of the year in which the financial markets were ‘obsessed’ about when the Fed would raise short-term interest rates. “There are plenty of examples of central banks that made the wrong interest-rate decision at the wrong time,” says Van Trigt. “I'm no longer expecting an interest-rate hike this year, and the Fed may do nothing initially in 2016 either.”
According to Van Trigt, who also manages the Robeco Global Total Return Bond Fund (previously Rorento), it’s like walking a tightrope. On the one hand, the Fed would like to normalize rates. “The fact that policymakers at the central bank have been dropping repeated hints about the first rate hike in seven years, show just how strong the US economy is and that the period of recession is definitely coming to a close.”
However, there was (and still is) uncertainty about economic developments outside the US, particularly in China, and their effect on the economy. “US production is suffering as a result of the economic slowdown in China and the dollar’s strength, which is causing exports to fall. The Fed has a tricky decision to make.”
The economic recovery in the United States is already a step ahead of that in Europe and Japan. The European Central Bank is still discussing whether its bond buying program should be expanded, at some stage perhaps also to include corporate bonds. According to Van Trigt, Japan will probably also increase its monetary stimulus. “The normalization of US interest rates and the monetary easing in Europe and Japan will create volatility on the financial markets next year.”
The current global situation of sluggish economic growth and low inflation is potentially attractive for bond investors. However, the historically low interest rates mean low yields, so any increase in rates could cause bond prices to fall. According to Van Trigt, flexibility, maintaining a global view and being selective is the mantra for bond investors who want to generate good returns under these conditions. “A global approach is increasingly important for bonds and our flexible strategy enables us to invest without being restricted by an index and to easily adjust interest-rate sensitivity and credit risk. But as investors we still have to be alert.”
‘Focus has shifted from bond holders to shareholders and shareholder value’
In his quest for returns, Van Trigt sees attractive investment opportunities in Australian and Spanish government bonds. “Australia is still relatively unknown. The economy is having to reinvent itself because it is heavily dependent on raw material exports to China, which are earning less and less. It is also one of the few countries that is still able to lower its official interest rates, which offers the chance of capital gains. The credit risk is minimal, which is also reflected in the country’s AAA rating.”
Van Trigt prefers US Treasuries to European government bonds as the traditional safe haven in the event that financial markets come under more pressure. In Europe, the fund manager prefers Spanish government bonds to Italian ones. "Spanish bonds are undervalued because of the elections there. Wrongly so, because the Spanish economy is doing better than Italy and its debt as a percentage of GDP is smaller.”
In the last year corporate-bond spreads have increased. According to Van Trigt, “The years of rapidly falling credit spreads are behind us. In many segments such as investment grade, high yield and emerging market corporate debt, valuations are not particularly attractive.”
In contrast, he feels that subordinated bonds from European banks and insurers do offer value, although they fall into the most risky corporate bond category. “Banks have reverted to being the boring sector they were before the financial crisis. They are becoming more streamlined, improving their transparency and taking less risk. They are also more strictly regulated – something that bond investors actually appreciate, unlike their fellow equity holders.” But he believes it is important to be selective here too. As a fund manager, he prefers bonds from north-western European banks rather than southern European ones, and has specific preferences for certain names within any given country.
Van Trigt observes that the focus of companies has shifted from bond holders to shareholders and shareholder value, particularly in the US, where the credit cycle has once again entered a phase where companies have more debt and leverage is increasing. Corporations are issuing more bonds to finance takeovers or dividend payments. That is something that bond investors are not keen on.
“In developed markets, we therefore prefer European credits, as companies in the region do not yet have a high debt burden,” says Van Trigt.
In emerging markets, it is a question of waiting for a turnaround. The many years of expansionary monetary policy in Western countries allowed emerging markets to borrow money cheaply, which created a debt bubble. That bubble has now burst and the emerging countries will continue to suffer the after effects in 2016. According to Van Trigt, governments need to show that they are intervening and implementing reforms necessary for economic recovery. “The long-term solution is for these countries to reduce their debt, increase productivity and find new export opportunities. In the short-term, though, they have chosen to let their currencies depreciate,” says Van Trigt.
Van Trigt sees a parallel with the European periphery of a few years ago. “Back then, nobody wanted bonds from countries like Spain, Italy and Portugal either. After economic reforms and monetary stimulus, things changed.” He does think that the financial markets tend to lump all the emerging countries together. “Even a country like Mexico has been caught up in the poor sentiment and is not being rewarded for its good policies.”
What Van Trigt does find striking is that emerging markets have not suffered more rating downgrades over the last year. “It's weird to see countries like Turkey, South Africa and Brazil currently with similar credit ratings to Spain or Italy. But rating agencies tend to respond slowly to events so we can expect further downgrades in 2016. This also fuels the market’s negative sentiment towards emerging markets.”
Van Trigt sees currency depreciation as a problem for companies in emerging markets. Their bonds are issued in US dollars, but corporate earnings are often in a much weaker local currency. This means that levels of debt have increased, when measured in local currency terms.
The world will still be a challenging place for bond investors in 2016 – something that makes an active investment policy indispensable, according to Van Trigt. “But there are always plenty of opportunities for anyone who invests worldwide and has a flexible investment style.”
Robeco's best-known bond fund Rorento now has a new name. This global bond fund will from now on be called Robeco Global Total Return Bond Fund. According to its fund manager Kommer van Trigt, the new name better reflects what it does. "Rorento may be a familiar name in the Netherlands, but it is not well-known abroad. The new name makes it clear that it is a Robeco investment fund that invests in bonds worldwide. The investment style is flexible in terms of interest-rate sensitivity and credit risk.”