Search for yield has returned; in fixed income and in equities

The search for income generating asset classes has to a certain extent come back on investors’ minds.

This has translated in a recovery in government bond markets and the relative performance of income generating equity sectors like telecom, utilities and real estate. It is also is visible in the renewed appetite for fixed income spread products like emerging market debt (EMD) and high yield (HY) which have seen healthy inflows again in recent months. Steady growth, increasing participation of the emerging market (EM) region, low defaults and accelerating profit growth are just a few reasons that continue to support these asset classes.

The only real headwind is valuation concerns. Valuations of HY credits and EMD hard currency bonds have become less compelling, with spreads having tightened and the potential for rising interest rates and less central bank support going forward. The latter does not mean that monetary policy will not remain accommodative, as both the Federal Reserve and the ECB have again emphasised that policy normalisation will happen only very gradually. The recent string of relatively soft inflation data in both the US and Europe also does not point at a swift reversal of monetary policy. Hence, we expect central bank policies will not derail the search for yield. The ECB’s asset buying program still provides a very supportive technical picture for European HY, for example, while this category is also supported by the decrease in political risk and the improving macroeconomic and corporate fundamentals in Europe. These arguments also apply to European Investment Grade (IG) credits.

As far as EMD hard currency is concerned, the asset class is probably fairly valued from its own historical perspective considering the improving EM fundamentals, but relative to other comparable fixed income asset classes the valuation is still attractive. On the other hand, EM economic data surprises, like in most other regions, have declined recently while momentum and sentiment indicators weakened a bit, partly due to the corruption scandal in Brazil.

Valentijn van Nieuwenhuijzen – CIO – NN Investment Partners