We are also seeing good opportunities to invest in hybrid bonds. Ranking between equity and normal senior debt, these have advantages both for issuers and investors.
Borrowers want to preserve their credit ratings, and hybrid bonds provide a mechanism that allows them to borrow money without jeopardising this. For investors, hybrids are attractive because the higher level of risk is rewarded with a better return than senior debt from the same issuer. That is particularly appealing in the current low interest rate environment.
Looking at other parts of the bond market, I expect to see further opportunities within high yield. Investors have already enjoyed a strong rally and yields in some parts of the market are not much above levels normally associated with investment grade debt. However, their main attraction is that default rates are set to remain low and as long as companies have access to funding, this should remain the case. Again though, it is vital to emphasise the importance of thorough research. Valuations have risen and yields fallen and investors need to be alert to event risks stemming from corporate activity. I am becoming more concerned with event risk in the US market than in Europe. A better economic outlook is likely to lead to a return of more of Keynes’ ‘animal spirits’ in boardrooms.
Meanwhile, with central banks (both tacitly and explicitly) targeting growth at the expense of inflation, the index-linked market cannot be ignored. This is a market we have traded on a strategic basis in recent months. Although some do not have a heavy presence in the index-linked market at the time of writing, it is possible they will probably adopt further opportunistic positions as they occur across different parts of the yield curve.
Overall, what is clear is that to generate returns in coming years investors will need to be increasingly nimble. I see plenty of opportunities for generating positive returns, although risks remain.
Therefore the ability to adjust asset allocation quickly, combined with the skill to generate stock-specific alpha, will be key to delivering returns from here.
Luke Hickmore is investment director in the fixed income team for fund manager Swip
Key points
- The ability for strategic bond funds to allocate risk using the whole of the bond market has understandably become a major attraction.
