By Arif Husain
Head of International Fixed Income
Portfolio Manager for the Dynamic Global Bond Fund
Fixed income investors endured a rough ride in the first half of 2016. Safe haven sovereign yields fell and risk premiums initially spiked amid concerns over the speed of China’s economic deceleration, collapsing oil prices and the timing of the Federal Reserve’s next rate hike. However, risk appetite returned in mid-February as China shifted its focus from restructuring the economy to supporting growth, commodity prices rebounded, and major central banks assumed a more dovish stance.
Britain’s vote to leave the EU in late June halted this momentum. News of the ‘leave’ vote caused higher quality bond market yields to fall to new lows and, initially at least, demand for riskier assets to decline. Over the next few months, uncertainty surrounding the implications of Britain’s decision to leave the EU including the direct impact on growth rates there and elsewhere, will leave markets susceptible to bouts of risk aversion and subsequent relief rallies.
There remains a strong structural argument for yields remaining low for the long term. However, recent economic data has been surprisingly positive – apart from the UK, there has been little evidence of a post-Brexit move towards global recession. Higher yields in the short term particularly in the U.S., are a possibility. In this environment, a smart investment strategy may be to identify countries where yields are relatively high and may have potential to decline due to disinflation and subdued growth. Australia’s Reserve Bank, for example, reduced rates in May and again early this month, and could do so again before year-end. Although further cuts have been largely been priced in, intermediate-term Australian bonds should remain resilient if U.S. yields rise.
As we head into the second half of the year, investors find themselves facing multiple risks. Markets are bracing for complex, drawn out, and disruptive post-Brexit negotiations. The Chinese government is walking a fine line between supporting growth and discouraging the accumulation of even more debt. Meanwhile, the Fed faces a difficult situation, wanting to raise rates to gain policy flexibility and keep credit growth from overheating, but also wary of these global headwinds de-railing the moderately paced US growth cycle. Investors are keenly looking for signs of growth in Europe and Japan amid concerns that central bank policy tools have lost their potency; they are also watching to see if the current floor under oil prices is really sustainable given oversupply.
With overall valuations again at less attractive levels, risks appear to be asymmetric – offering more downside than upside. In this environment, we believe investors will benefit from a long-term focus and an unconstrained, flexible, risk-aware approach. Our Dynamic Global Bond Strategy is designed to use this approach to deliver positive returns from global fixed income markets, with particular focus on downside risk management and providing diversification away from equities. One of the advantages of an unconstrained approach is that it gives us the freedom to move quickly in and out of major short- and long-duration positions as the markets change. This enables us to take – or hedge – risk where it appears most advantageous, while maintaining sufficient liquidity in portfolios to be able to ride out turbulent markets and exploit ensuing opportunities.
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