Kames: How to pick winners in bond markets amid ‘ridiculous’ yields

Fixed income markets have continued to surprise investors so far in 2015, with a plunge in core bond yields to fresh lows leaving investors with some tough calls to make about where value still exists, Kames Capital’s David Roberts has said.
The latest rally for fixed income markets has left yields at ‘ridiculous’ levels, according to Roberts. But while investors may now be wondering what returns – if any – core government bonds can offer this year, Roberts said a relative value approach taking advantage of heightened volatility could still provide investors with attractive returns.
Roberts, head of fixed income at Kames and co-manager of the group’s £719 million Strategic Bond* says: “Where we go in the short term is unclear and perhaps the path of least resistance is to follow the trend to lower yields: zero is clearly no barrier, however illogical it seems.
“That may be the way to optimise returns but taking advantage of heightened volatility and stretched intra-market values continues to be a lower-risk way to make money for investors. While yields are ridiculous – and may become more so – and policy is set for crisis more than ever before, global growth will be close to trend in 2015 and inflation will accelerate in the second half.”
Roberts noted 2015 has already begun as an accelerated version of 2014, but with so many unknowns surrounding QE and central bank policy in particular, he said investors needed to tread carefully.
As such Roberts and his co-manager on the fund, Phil Milburn, continue to run a ‘beta light’ strategy, remaining correlated with broad markets in line with their mandate, whilst also looking to respect valuations and fundamental data in an effort to avoid having too much exposure to areas which are at risk of delivering negative returns.
“Demand for core government debt remains at giddy heights and anything as prosaic as value is being ignored: a real rate of return is so ‘last decade’,” says Roberts.
“In such an environment, our strategy remains simple: we will not short the market and do not want to risk our clients’ money by being aggressively long. We are looking for relative-value opportunities and thankfully they remain plentiful.”
Recent examples include being long Canadian and Australian bonds relative to the US.
As for investment grade, Roberts says this paper is typically fine until well into a tightening cycle – and that remains some way in the future.
While defaults continue to be negligible, he believes we may see an increase in ‘transition rates’ as rating agencies alter company’s bonds, usually from investment grade to junk.
“Balance sheets for many commodity producers, for example, are more stretched than for some time and ratings are likely to come under pressure there,” says Roberts. “But for now, with defaults no more than a distant blot on the horizon, we remain heavily weighted to investment grade credit. If pushed for a date when this might change, I would estimate quarter two of 2016.”