Bond buzz continues as central bank restarts QE

How the ECB’s stimulus measures will impact fixed income portfolio allocations

Mario Draghi ECB

At the beginning of September, the European Fund and Asset Management Association (Efama) published data confirming sustained interest in fixed income funds in the second quarter of 2019. The figures showed net sales hit €83bn in April, May and June 2019, following similar inflows of €82bn in the previous quarter.

By contrast, there were persisting outflows from equities, with net sales of equity funds at -€32bn for Q2 2019, fuelled by the ongoing US-China trade war and global political uncertainties.

Joern Wasmund, head of fixed income at German fund manager DWS, said negative yields on cash and government bonds had driven investors out of those asset classes and into multi-sector and higher yielding bond funds, in particular.

“It is a rotation from cash to fixed income,” he said. “With correlations between equity / risk assets and bonds turning more ‘normal’ again, bonds serve as a good diversifier for multi-asset portfolios.”

According to DWS, there has been growing demand from for alternative credit assets, including infrastructure, real estate, private placements and middle market debt.

“We turned bearish on core European bonds in late 2018 as we believe other bond markets with much higher yields are more attractive.”

The ESG Factor

A further trend driving European investors to bonds is the ESG factor. This year has seen a growing number of asset managers launching bond funds with a sustainable angle as investor demand for sustainable investment solutions intensifies. As well as DWS, which launched its €2bn ESG Euro Corporate Bond in July, Nordea Asset Management (NAM) introduced an ESG-integrated bond earlier this year with its Nordea 1 Emerging Stars Bond Fund.

“The market is beginning to take notice,” a spokesperson for Nordea Asset Management said. “There is growing recognition among investors that ESG issues can present material credit risk with respect to sovereign debt.”

Nordea said investors have been particularly attracted to emerging markets bonds because of the return profile over the medium to the long term.

“Emerging market spreads look attractive relative to similarly rated US bonds,” the spokesperson said. “EM debt is showing relative value opportunities considering the spread versus credit quality of the countries. In short, emerging markets spreads are currently attractive given the level of credit risk.”

Last month, Austrian financial group Raiffeisen KAG converted its Euro-Plus Rent bond fund into the Sustainability Rent Fund to meet the current trends in the bond market. As well as the ESG incentive, the bond’s more global focus allows investors to reduce their exposure to Europe.

“The global yield landscape has changed tremendously, especially in Europe. Negative yields are nowhere as prevalent as in Europe. That is why it is worthwhile to involve the rest of the world more closely,” the company said in a statement.

The ECB influence

With investment in global fixed income assets ranging from government bonds to currencies and corporate bonds, and a risk-return strategy that focuses on emerging market bonds, inflation-linked bonds and euro-denominated investment grade corporate bonds, Raiffeisen’s bond is indicative of current market appetite.

According to Kevin Zhao, head of global sovereign and currency, fixed income division at UBS Asset Management, the launch of the European Central Bank’s (ECB) quantitative easing programme has seen investors shift more to longer maturity bonds, higher-yielding corporate bonds and covered bond markets.

In addition to the UBS Global Dynamic and Global Strategic Bond funds, the Swiss asset manager has established a World Income fund and Fixed Maturity fund to meet investor appetite for higher yields.

“We had been very positive on European bonds since 2012 due to weak growth, low inflation and fiscal austerity after the European sovereign crisis during 2011 to 2013,” Zhao said.

“However, we turned bearish on core European bonds in late 2018 as we believe other bond markets with much higher yields are more attractive.”

These ‘more attractive’ markets include US bonds, as well as a few emerging markets bonds such as China and Mexico whose economies were negatively affected by the recent trade war, Zhao said.

“We believe the trade war is negative for growth for all countries involved, consequently central banks would need to cut rates.”

Limited risk appetites

In July, Muzinich launched a short duration investment grade bond fund in response to strong investor demand. The Global Short Duration Investment Grade Fund, which also focuses on ESG considerations, launched originally with €352m in assets with a maximum duration of 1.5 years.

Tom Douie, global head of distribution at Muzinich, said the company has seen appetite for global investment grade short duration strategies from investors seeking to enhance returns while limiting credit and interest rate risk.

“Investors with a higher risk tolerance are looking at higher yielding strategies, such as those with exposure to emerging markets, or multi-asset portfolios which can seek to generate higher yields through greater diversification.

“For those who can tolerate illiquid strategies, private debt is proving a popular way to enhance investment yields by benefiting from the illiquidity premium. ESG factors are also becoming an increasingly important focus for investors,” Douie added.

Muzinch’s current credit asset allocation mix favours high yielding instruments with “reasonable visibility”, Douie explained. Typically, subordinated bonds and hybrids bonds with a senior investment grade rating make up a large part of this credit allocation.

“We also like European loans because many have a zero floor on the coupon and are less sensitive to the ECB’s negative rate policy. They also enjoy low volatility.

“In the investment grade space, we prefer the BBB rated corporates which can offer a nice recovery in case of economic upturn and will also benefit from the ECB purchase programme. We would not have large exposure to the weakest part of the high yield market at a time where economic risks remain titled on the downside,” Douie explained.

For DWS, the take up of bonds is likely to persist for some time, especially as the ECB continues to lower interest rates – which it did this week with the decrease in its deposit rate to minus 0.5%.

“The rotation out of cash into higher yielding fixed income will probably last as long as the short term interest rates remain negative and the ECB does not change policy,” Wasmund said.

For more insight on continental European investment, please click on www.expertinvestoreurope.com

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