Leading managers share their thoughts on developed and emerging market debt alongside currency markets for the year ahead.
Bond market: good while it lasted
There seems to be a consensus among bond managers that it was good while it lasted. With the steady decline in yields, it appears the maths of fixed income investing will be harder to add up in 2013 than in this year.
Bullishness is mostly heard with reference to emerging market debt. Against a backdrop of deteriorating fiscal and economic fundamentals in the developed world, this is likely to emerge in the New Year as the most popular theme for bond investors.
High yield starts to look a little sheepish yet still bulls can be found in the field. The question of a credit bubble still hangs over the sector that, for some, is bobbing along on quantitative easing rather than fundamentals.
High yield and corporates
They may have been the darling asset for investors hunting out returns in 2012 but the rally looks to have hit a turning point. Things look better for those already invested than those looking to buy in, according to Lombard Odier’s investment strategy committee.
‘Credit, with mid-single-digit expected returns, warrants a neutral stance but not sufficient to recommend adding to exposure at this stage,’ the committee stated in its latest outlook.
Yet the world’s biggest high yield market, the US, looks to promise solid returns next year, according to Merrill Lynch’s WM EMEA’s CIO, Johan Jooste.
‘US high yield may benefit from better growth expectations and a benign default rate environment,’ he said, adding that he would prefer below-investment grade to fixed income assets that would be vulnerable to a sell-off should the Fed raise interest rates.
Emerging market debt
Emerging market debt is increasingly seen as a mainstream asset class yet remains entrenched within the global financial crisis.
‘We are under no illusions that these countries will completely ''decouple'' from the rest of the world,’ according to Schroders’ James Barrineau, manager of the Schroder ISF Emerging Market Bond fund.
With over two-thirds of the index for emerging market sovereign debt with investment grade accreditation, sovereigns trade with increasingly high correlation to US rates and as such those rated just a notch or two below investment grade are seen to be even more attractive.
‘The rally in emerging market debt of the past few years has also left valuations looking too expensive,’ he added.
The coming year for euro area sovereigns looks again to be underlined by sovereign and banking issues. Combined with limited growth prospects, the ECB is expected to be as active with monetary policy in 2013 as in the past year.
‘2013 will likely see the activation of the new ECB assistance programme, the OMT, which will assist recipient countries to fund in the short term,’ said David Simner, manager of Fidelity’s Fidelity Funds - Euro Balanced fund.
Low yields in ‘core’ euro area government bonds will continue to haunt investors looking for safety in 2013, according to Enzo Puntillo, manager of the Julius Baer BF Emerging-EUR fund, at Swiss & Global, who added that government bonds were destroying purchasing power in their respective economies.
Yet bonds from peripheral countries in Portugal, Ireland, Spain and Italy will look increasingly attractive as the worst has already past, according to Stefan Kreuzkamp who manages the DWS TopZins fund.
‘The ECB bond repurchase scheme covers the downside risk, and secondly the vast majority of growth- inhibiting austerity measures in these countries will have been completed in 2012,’ said Kreuzkamp.
The tremendous interest attracted by local currency in emerging markets is likely to cool, according to Schroders’ Barrineau.
‘We think returns will moderate in 2013, possibly significantly. We enter a year with future rate cuts likely to be confined to the Europeans (central banks),’ he said.
The next currency rally is set not to occur in hard currencies, according to Andrew Wells, CIO for fixed income at Fidelity as he sees that towards the end of 2013 investors in developed economies will have inflationary hazard on the agenda.
It is estimated that it will cost the Bank of Japan $1 trillion of quantative easing in order to weaken the yen by 10%. Still, according to DWS’ CIO for Europe, Neil Dwane, a weakening of the yen is likely on the back of central bank action.
‘There is also a very high probability of much more aggressive quantitative easing in Japan, which could have a dramatic effect on global bond markets, particularly if further monetisation by the Bank of Japan weakens the yen significantly,’ Dwane said.