Tough choices
Fraser Lundie, co-head of credit at Hermes Investment Management, is eyeing opportunities being created by the global commodities market.
“With interest rates likely to increase, duration risk becoming more potent and correlations rising across markets, credit investors can no longer afford to rely on government bonds and diversification for protection,” he says.
“We expect yields and prices to be governed by factors closely linked to this, namely dollar FX, commodities, Fed policy and geopolitical risks. We favour a pro-cyclical sector exposure, benefiting from the bottoming out of commodity markets and a continued technical under ownership.
“That said, avoiding interest rate and default risk remains key, and so focusing attention in the middle ground, high end of high yield and low end of investment grade, as well as allocating capital on a global basis, will be prudent.”
Lundie also warns against any indiscriminate moves into high-yield credit. “The global hunt for yield, weaker covenant protections with related ‘asset leakage’, combined with widespread low interest rates, has prolonged the life of moribund companies, leaving creditors with minimal residual recovery values when those companies finally collapse,” he says.
“Because downside risks are now far greater than in the past, we do not believe gambling with default risk to deliver performance makes sense. As a result, avoiding a broad-brush allocation to low-quality high-yield credit is vital.”
“On the whole, there is still some value in bonds,” says Ian Spreadbury, manager of the Fidelity MoneyBuilder Income Fund.
“However, with all the macro and political changes, efficient allocation, conservative name selection and careful liquidity management will be required.
“In terms of asset classes, corporate bonds look attractive. Default rates are likely to stay low and high-quality investment-grade bonds, with yields of around 3% in the UK and US, are relatively appealing.
“There is selective value in inflation-linked bonds, which had a good run in 2016, but exposure to this asset class will not come without volatility over the next 12 months,” he adds.
“We are cautious on emerging market debt given the developments in the US, and we are also somewhat concerned that valuations in Europe do not fully reflect the significant amount of political uncertainty on the horizon in 2017.”
