Going Global to Expand Income Potential
Going Global to Expand Income Potential
What are the key themes likely to shape markets in 2019?
The most important is whether the Fed will raise rates at its anticipated cadence. Much of what will occur in bond markets – and the economy – will be influenced by the Fed’s actions. While some expect an even more aggressive Fed, given its history of caution, we believe it will err on the dovish side. The threat of an escalating trade war and the broader prospect of slowing global growth are two factors that could necessitate a pause on rates. A second theme is that higher rates are here to stay. The autumn’s equity volatility did not send bond yields materially lower. While still below historical levels, higher rates could put pressure on earnings and economic growth. The absence of inflation, however, should keep a lid on longer-dated yields, with the result being a flattening yield curve. But a flatter, or even inverse, curve does not necessarily portend recession, in part due to lower term premiums.
Where do you see the most important opportunities and risks within your asset class?
We are looking beyond U.S. shores for the most attractive opportunities, namely in softening economies where central banks are likely to hold rates steady or lower them. Australia and New Zealand are two examples. With the Fed ahead of other developed market central banks, holding excessive duration in the U.S. looks risky. Bond investors typically stay within their comfort zones, but we live in an interconnected world and investors can generate attractive returns on a hedged basis when looking internationally. On the credit side, we think quasi-sovereign companies or structurally advantaged industries such as banking and infrastructure, where the – often regulatory – barriers to entry are high, present attractive sources of income generation. The largest risk to markets would be the combination of a more aggressive Fed coupled with widening credit spreads. An unexpected acceleration in inflation, trade disputes hurting margins and an extended credit cycle are factors that could contribute to such a scenario.
How have your experiences in 2018 shifted your approach or outlook for 2019?
For over a decade we have approached markets with an absolute-return mindset and an acute focus on keeping volatility low to minimize drawdowns and steadily generate income. In recent years, others took a different approach, adopting aggressive tactics to achieve returns they have come to expect. Often this involved leverage or increasing exposure to lower-quality assets. In 2018, we were reminded that reaching for yield doesn’t always pay. Rising rates and normalizing volatility can be a lethal combination for leveraged strategies. A faster-than-expected uptick in inflation and any corresponding Fed reaction could see additional shakeout among these strategies. Given the divergence of prospects globally, both in terms of monetary policy and the business cycle, this past year has also provided us evidence that by judiciously expanding one’s opportunity set, especially internationally, bond investors can still position themselves to meet return objectives without doubling down on the riskiest tools in the toolkit.
Global 10-Year Government Bond Yields
Certain countries, including Australia and New Zealand, offer bond yields similar to the U.S., but are likely to keep interest rates on hold, thus limiting duration risk.
Source: Bloomberg, as of 10/31/18
Search for Income
"Much of what will occur in bond markets – and the economy – will be influenced by the Fed’s actions. While some expect an even more aggressive Fed, given its history of caution, we believe it will err on the dovish side. The threat of an escalating trade war and the broader prospect of slowing global growth are two factors that could necessitate a pause on rates." – Nick Maroutsos, Co-Head of Global Bonds | Portfolio Manager
Our short-duration, absolute return approach may make sense for those seeking returns above cash or to diversify their traditional core fixed income.
What else do our experts see for the year ahead?
All Eyes on the Fed
As the Fed risks executing on an overly aggressive tightening path, and the economic and credit cycles continue to progress, Portfolio Manager Seth Meyer highlights the importance of a nimble approach, in which capital can be dynamically allocated to the strongest risk-adjusted opportunities, regardless of fixed income asset class.
Strategic Fixed Income: End of the Cycle… Are We There Yet?
With the markets finally coming around to the idea of the late-cycle stage in economies, Jenna Barnard and John Pattullo, Co-Heads of Strategic Fixed Income, expand on the risks and opportunities likely to arise from this theme in 2019.