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Fixed income, what is it good for? Absolutely nothing?

  • By Jason Stockwell

David Jane, fund manager, Miton multi-asset fund range, reflects on what 2019 might have in store for bond markets


In recent months, bond yields have headed higher in most markets, leading to capital losses across the fixed income spectrum. As the Fed is seemingly committed to continued rate rises and the ECB to withdrawing from QE, we expect to see yields rise further in 2019.

Inverse correlation?

The equity market’s recent setback hasn’t seen a material fall in bond yields. If anything, the opposite has occurred. Bonds’ promise of inverse correlation isn’t bearing fruit.

The equity market has been fretting about an economic slowdown, but this hasn’t fed through into corporate bond credit spreads, implying the bond market is more sanguine about the economic outlook than equities. This leads to a quite unusual scenario ahead of 2019, shifting away from the belief that credit spreads act as a lead indicator.

Commentators have highlighted that corporate debt is running at very high levels, partly due to ultralow interest rates. It’s however set to remain highly affordable. Even with the expected interest rate rises 2019 will bring, on most realistic scenarios interest costs will likely still be very manageable for the average company.

However, this average hides the fact that there are plenty of zombie companies already struggling to service their interest bill, despite a benign economy and favourable investment market. As interest rates rise, or if the economy takes a turn for the worse, investors will be less willing to lend to companies without the means to repay.

The historic purpose of bonds, a low risk income generating diversifier which performed well when equities were weak, no longer holds true

The historic purpose of bonds, a low risk income generating diversifier which performed well when equities were weak, no longer holds true. Most scenarios that are negative for equities will also be negative for bonds, tearing down the belief in the negative correlation of government bond yields to equities.

There’s got to be a better way?

The market environment going into 2019 will force investors to look more widely for diversification and risk-off type assets. From a multi asset investing perspective, options include lowly indebted infrastructure equities, particularly where they’re less economically sensitive. These assets can often grow revenues close to nominal GDP, giving some protection against rising interest rates, particularly if their debt is long dated. Examples we believe are attractive include holdings in airports, railroads, pipelines and telecommunication networks. Clearly, each comes with a higher degree of equity beta than corporate bonds and has its own amount of sector specific risk, but as lower risk assets than mainstream equities, they can provide some buffer to equity volatility.

Real estate investment trust (REITS) are another way we’re tackling diversification. Despite the fact that property is valued closely off interest rates and most REITS have significant amounts of debt, rising inflation is a big driver of rents. Exposure to gold is another risk-off inflation hedge.

Diversification will pose new financial challenges in 2019. The new investment environment means the simplistic multi asset approach of combining long dated bonds with equity is outdated. A more nuanced approach is required. It’s important to consider the risks that need to be diversified away, and recognise that equity beta is much more unavoidable than it has been for some time.

The market environment going into 2019 will force investors to look more widely for diversification and risk-off type assets


About David Jane

David Jane joined Miton Group plc in June 2014. He founded Darwin Investment Management Ltd in September 2010 and prior to that he was Head of Equities Investments at M&G. David joined M&G in December 2000 as a Fund Manager in the global specialist equity team before becoming Head of Equities investments. Prior to M&G, David was the Head of Global Financials Research at AXA Investment Management and before that he was at Newton Investment Management as Director of Global Financials Research. David graduated from Keele University with a B.A. Honours in Economics, Statistics and Operations Research.

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