Timing is right for global multi-sector bonds
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With Canadian bond yields at “rock bottom,” T. Rowe Price Group vice-president Terry Moore says investors need to look further afield and at different sectors in order to grow their fixed-income portfolios.
“The time is right to embrace a global multi-sector bond investment and seek higher returns from the wider opportunity set, while also potentially reducing portfolio risk and volatility,” he said.
He believes there are opportunities in a wide variety of corporate and sovereign bonds around the world — but portfolio adjustments may be necessary as conditions change.
For example, Moore trimmed recent strong performers like U.S. and European high-yield corporate bonds, investment-grade corporate bonds, and agency mortgage-backed securities. In their place, he turned to reflation trades: certain parts of the U.S. securitized credit market, some emerging-market corporate bonds and U.S. taxable municipal bonds. He chose these securities because they were not directly supported by central-bank purchase programs and were adversely affected by shutdowns.
He described global sovereign bonds as the “dry powder” in his portfolio that will give him the liquidity to take advantage when bond valuations cheapen.
Moore said he is also looking for opportunities in bank loans, which boast good levels of credit protection while lately yielding returns comparable to high-yield corporate bonds.
“They are effectively high-yield paper but they sit higher in the capital structure than high-yield corporate bonds,” he explained. “And because of this higher level of credit protection, the yield on bank loans is typically lower than the high-yield corporate bond yield. But recently they’ve converged. So, we think the bank loans start to look attractive today.”
He explained that bank loans are essentially floating rate notes, which means their yields adjust with the margin over short-term London Interbank Offered Rate (LIBOR) rates. So post-Covid, when economic growth and inflation returns and longer-maturity interest rates rise, bank loans should do well, Moore said.
Among the sectors he favours are ones that were hardest hit by Covid. Post-pandemic, he anticipates a quick return of fundamentals in industries like airlines, manufacturing, restaurants, consumer products, retail, energy, and automobiles.
He also believes commercial mortgage-backed securities, which have lagged in the past year, could bounce back, adding that tranches that are secured by “trophy assets” could offer attractive relative value.
In terms of countries, he likes South Korea, Israel, Australia, Malaysia, and Chile, all of which are levered to the expected rebound in global growth. He said the real government bonds yields in these countries are attractive, compared to the negative real yields of Government of Canada bonds.
“Malaysia, for example, offers a positive 70-basis-point real yield. And Indonesia’s real yield is over 3%. So, there are opportunities globally to add some value, even on the government bond side,” he said.
Moore said countries leading on the stimulus and the vaccine fronts will likely be able to open their economies sooner and could see the first signs of higher interest rates. “In our opinion, it’s likely to be the U.S., Canada, Germany, the U.K. and in our global bond portfolios we’re underweight duration in these countries.”
Moore said the duration of the core-bond universe is about 8.5 years.
“If interest rates were to, let’s just say generally, rise by 1%, the bond math on that is a price return of about negative 8% or so. That’s a big risk to consider,” he said — and why he advocates taking an active approach to bond management.
“If an investor goes with a passive portfolio, they own that full duration risk. But an active portfolio may be able to reduce that duration risk either by buying shorter-duration assets, hedging some of the duration risk or buying less-correlated bonds from other countries,” he said.
Moore said fixed-income investors need to be flexible through current market contortions.
“We’re always looking at those opportunities across the yield curve and across the credit curve,” he said.
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.
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