Fixed income’s active age

Ben Hurley

By

28/02/2018

MFS Investment Management’s fixed income expert Pilar Gomez-Bravo reminds investors of the importance of an allocation to long-dated bonds and urges an active approach to credit.

SPONSORED CONTENT | After a long period of eerie quiet, volatility finally returned to global bond markets in early February. And with the ‘great unwind’ still to play out over the coming months and years, as unprecedented amounts of central bank stimulus are unwound, the outlook for traditional fixed income is tough.

Institutional investors should not veer away from fixed income, but must be ready to react swiftly to market dislocations, argues Pilar Gomez-Bravo who is the head of fixed income for Europe at MFS Investment Management.

With the lessons of the GFC fading in investors’ memories, and in response to some disappointing returns from fixed income in early 2018, Gomez-Bravo has been concerned to see some institutions pursuing riskier fixed income strategies in a search for yield and losing sight of the important role bonds play in portfolio diversification and capital preservation.

“Avoiding long-dated bonds due to concerns about rate rises misses the point of what fixed income is about,” she says. “Fixed income has traditionally acted as ballast in a diversified portfolio, and investors need to keep this in mind and preserve their capital.”

Support for bonds

In her view, concerns about the current environment leading to another ‘taper tantrum’ seem unlikely to play out.

“In 2013, markets reacted ahead of the potential for a sudden change of Federal Reserve policy. We now have far more transparency around both the pace and quantity of balance sheet reduction,” Gomez-Bravo says. “Furthermore, markets are priced for two to three further hikes by the Fed in 2018. This means sharp losses from fixed income are far less likely although volatility can be expected to increase.”

At the same time, more traditional bond portfolios will continue to provide diversification and protection to other asset classes, such as equities and commodities, she predicts.

The recent rise in US yields now means that the average dividend yield on the S&P 500 is lower than the two-year US Treasury for the first time since the financials crisis a decade ago.

Bond returns are also supported by funding gaps at pensions funds, which will favor rebalancing of portfolios away from equities and into fixed income, she says. “Demographics and an expanding global savings pool should also provide longer term technical support.”

Bonds provide ‘ballast’

Uncertainty about monetary policy and the maturity of the US corporate earnings cycle mean risks abound.

In the event of an equity market downturn, fixed income can help preserve capital and diversify a portfolio. But like in any asset class, individual investments must be chosen carefully, Gomez-Bravo says.

Corporate bonds, when risk-adjusted for quality and duration, tend to be “priced to perfection” with little upside and little room for anything to go wrong, she warns.

MFS Investment Management is a A$628 billion* Boston-based funds management house that has been managing fixed income assets for more than 40 years with around A$78 billion* invested in the asset class.

The firm has a focus on collaboration among adherents to different investment disciplines; embedding credit analysts alongside equity analysts. This allows MFS to take a dynamic and nimble approach to fixed income markets and take advantage of dislocations global markets are likely to start seeing.

Active approach to credit

Their house view is that it is now more important than ever for investors to engage in active security selection and prudent risk management to ensure they are adequately compensated for risk.

“Given that volatility has been suppressed for so long due to central bank interventions, we think active management will be more important going forward, as central banks start withdrawing liquidity from the system,” Gomez-Bravo says. “We advocate for being active. Think about the capital preservation that fixed income can provide – the anchor – but make sure you are dynamic and liquid so you can take advantage of [market] dislocation.”

*Disclaimer: Source MFS as at 31 December 2017. This article is directed at investment professionals for general information use only with no consideration given to specific investment objective, financial situation and particular needs of any specific person. Investment involves risk. Past performance is not indicative of future performance.

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