Fixed income spread sectors were under pressure during the last quarter of 2015 and into 2016.
But there has since been a rebound in these sectors, says Robert Abad, a product specialist at Western Asset Management in Pasadena, California. That means they’ll likely continue outperforming government bonds.
Abad, whose firm manages the Renaissance Multi-Sector Fixed Income Private Pool, credits this shift to moderate global growth, low inflation and declining bond yields, as well as to improving fundamentals in corporate U.S. credit and select emerging markets.
During the first six weeks of 2016, says Abad, his team took advantage of volatility by adding exposure to both investment-grade and high-yield issuers that “were indiscriminately penalized and trading well below fair value.”
And now, he explains, “we’re overweight credit risk, which reflects [our] portfolio’s current emphasis on global high-yield [and] investment-grade corporates, as well as emerging market bonds.”
Further, “we also have modest exposure to interest-rate risk via U.S. Treasuries. In this more volatile market environment, it’s important to have high-quality, liquid assets in the portfolio as a hedge against riskier assets. Looking ahead, we don’t expect to make any dramatic shifts with respect to our credit and interest rate risk position.”
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China still a concern
“The one area that is still percolating beneath the surface is China,” says Abad, noting there are still concerns about the growth of its external and private-sector debt.
“The policies that the Chinese authorities are putting in place [should] be sufficient to keep a lid on this particular issue for the time being,” he adds. But worries over China’s economy and debt will persist, and that’s “a risk we can’t ignore.”
China’s dark clouds—in combination with the collapse in commodity prices—have negatively impacted emerging market economies over the last two to three years.
Still, there’s been evidence of renewed interest in emerging markets, says Abad. “For example, we saw a record $4.9 billion flow into emerging market retail bond funds, and another $4.7 billion into Brazilian, South African, and Indian equities,” between July 18 and 22, according to Bank of America findings for that period.
“These are the largest one-week inflows into emerging markets over the past decade,” he notes.
Investors are turning to emerging markets mainly because of the low-rate environment, says Abad, and that isn’t going away any time soon. “It’s a matter of time until we see more retail and institutional investors shifting their gaze toward emerging markets as another source of incremental yield and portfolio diversification.”
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Abad has also seen strong foreign demand for U.S. investment-grade and high-yield corporate credit. “[Due to] a healthy rebound in commodity prices and [a decline in] emerging markets headline risk—the negative-yield dynamic is moving beyond Japan to other countries in Europe—we expect demand for U.S. dollar-denominated assets to keep on growing.”