Prospects for 2018
Paul Read, fixed income manager at Invesco Perpetual, says 2017 has been good for many of its portfolios, with the firm’s exposure to corporate hybrids, subordinated financial bonds, high yield and US dollar-denominated bonds all delivering outsized returns.
“However, as a consequence of this strong performance, we now start 2018 with many areas of the European bond market looking expensive,” he says.
“That said, a number of the factors that helped drive returns in 2017 remain in place. The demand for income remains very high and the ECB is still a dominant force in European credit markets. Although it is tapering its asset purchases, it is doing so very gradually and any actual hike in European interest rates still looks some way off. Amid improving economic data, ‘animal spirits’ are also high. Meanwhile, companies have been able to take advantage of low yields by refinancing debt at more attractive terms, so there is currently little pressure on default rates.
“This mixed backdrop of positive fundamentals but expensive valuations leads us toward a more balanced investment outlook. It is difficult to see a scenario in which yields move meaningfully lower, and so income is likely to be the main component of return in 2018.
“Overall, it is difficult to see bond markets repeating the kind of performance we have seen in 2017. Our focus is therefore defensive, and we are taking relatively ‘safe’ income where we can while waiting for better opportunities to add exposure.”
For Rush at Iboss the risk/reward outlook for bonds looks to be poor both in absolute terms and relative to history.
“We do however believe that bonds still have a place as the defensive portion of a portfolio,” he says.
“For that reason, we continue to hold a wide selection of bond funds but with a bias toward short-dated funds and cash for their defensive qualities but no explicit allocation to gilts, global emerging debt or high yield (other than through our strategic managers), preferring instead to take risk where the risk/reward profile is more positive in the medium term, ie some equity markets.”
