Bond markets, are there still interesting opportunities?

According to Carpaneda of M&G, the favoured areas include floating rate notes from corporate issuers, as these assets provide protection against rising yields

Currently, the market environment is characterised by low investments, changes to the growth models in Emerging Markets and political uncertainties in Europe, with central banks being forced to ease further their monetary policies to support economies. In this context, are there still interesting opportunities in the bond markets? These topics were covered during the Bond Vigilantes Forum 2015, the annual appointment with M&G Investments bond team.
Lmf International asked Nicolò Carpaneda, Investment Director, M&G Investments, to illustrate the trend of the bond market.

Carpaneda, what is your general view on fixed interest and in which areas you see more upside growth?
Within our retail range of flexible bond funds at M&G, we feel that the very low yields in government bond markets lack relative value and, therefore, our preferred areas of investment currently lie more in the corporate bond markets. In the latter, credit spreads have widened to levels that we believe over-compensate investors in an environment where default rates are likely to stay low. On a selective basis, our favoured areas of the market include floating rate notes (FRNs) from corporate issuers, as these assets provide protection against rising yields. We also consider that inflation protection is currently quite cheap and that inflation-linked bonds therefore represent a potentially attractive opportunity. Relevantly, for example, markets are currently pricing in five years of very low inflation in Europe, when in reality, periods of negative inflation have historically been extremely rare.

The low interest rates risk moving investments towards riskier products. Will the bond asset class remain attractive?
It has been the case that in the past few months we have seen outflows from fixed income funds, as retail investors have rebalanced their allocations in favour of riskier asset classes, such as equity and multi-asset funds. This is a normal phenomenon and the natural evolution of the investment cycle, following on from strong fixed income performances and positive retail flows over the past few years. Despite these flows, we continue to believe the asset class remains attractive, as institutional demand for fixed income remains strong. In addition, correlations between equities and government bonds have turned increasingly negative in the past few weeks, which means there are now even more diversification benefits to allocating to fixed income in the context of a balanced portfolio.

Talking about European Central Bank, QE will probably be extended and/or increased, what do you think?
The likelihood of increased quantitative easing (QE) activity by the ECB soon is a very topical theme at the moment. The market witnessed a very dovish European Central Bank (ECB) President Mario Draghi in late October. By committing to re-examining the ECB’s QE programme in December, Draghi has given a clear signal that QE will probably be extended and/or increased. It is clear that the ECB remains concerned about potential macroeconomic threats – either internal or from international developments – to the pace of the economic recovery in Europe and the implications this will have in meeting its inflation target of below, but close to, 2%. In addition, the slowdown in global growth has weighed on the ECB Governing Council, particularly the uncertainties around emerging market growth.

Now, what could happen on the bond market?
The ECB has already bought €478bn of bonds since QE was implemented (€13bn ABS, €122bn covered, €343bn government and supranational bonds), which is around 3% of GDP. By way of comparison, the Bank of England’s £375bn QE programme represents close to 20% of GDP. By this measure, it is clear that the ECB could act to increase its asset-purchase programme at its next meeting as there is plenty of scope to do more. Any move to beef up QE would likely support asset prices, particularly in European bond markets, and would probably result in a weaker euro.