Solving issues of liquidity and volatility in fixed income


At the roundtable, the role of exchange-traded funds (ETFs) in helping address the liquidity challenge and manage risk in fixed income was examined. Investors shared their experiences of using ETFs for short-term trades, tilting in portfolios and transitioning between managers.

We live in a new era of fixed income investing, with low yields and increased volatility, coupled with a lack of liquidity. Investors are reacting by being underweight core fixed income, looking further up the risk spectrum and looking at new ways to gain the desired exposures. The roundtable discussed these challenges, and heard that StatePlus and Sunsuper are both underweight core fixed income, and looking to high yield and private debt to generate returns.

The impact of Dodd Frank and Basel III is important to highlight, says Bigos.

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“So the challenge clients are facing is: where to access the liquidity when they want it? Primary market is one source and the issuance is there as borrowers take advantage of low borrowing costs. Just recently we’ve seen increased issuance in investment grade and high yield, but those deals were on average three times oversubscribed,” she says.

“We’re conscious of taking more risk, some liquidity risk, in the search for higher returns. That said, we’re not abandoning core fixed interest all together, we need that liquidity,” says Richard Dinham, head of research at StatePlus.


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Fixed Income: Should I Stay or Should I Go?


Veteran fixed-income investor Mark Vaselkiv of T. Rowe Price discusses the versatility and appeal of fixed income, even in a low- to negative-yield environment. Vaselkiv, a 30-year investment industry veteran, is manager of T. Rowe Price’s High Yield Fund and institutional high-yield strategies, and co-manager of the T. Rowe Price Global High Income Bond Fund.

P&I: What are the macro factors that are buffeting fixed-income investments and investors today?

Mark Vaselkiv: Since the financial crisis, growth has taken a dramatic leg down. We see a couple of reasons for that. One is that there is a demographic trend at work where, in Europe, the U.S. and particularly Japan, populations are getting older, and as populations age, consumption declines. Productivity has also plummeted, and that’s slowing growth. We also think that the significant amount of inequality in the global economy is a contributor.

Central banks have been trying to stimulate growth to make sure that we get out of this rut. When you think about central bank policy today, the G-10 countries [Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the U.K. and the U.S.] have issued about $34 trillion worth of sovereign debt. But about 35% of that carries a negative yield today, more than 70% is below 1%, and more than 90% is under 2%. It’s so different from anything we have experienced in our lives in the fixed-income world. And those sovereign rates really set yields and valuations for all kinds of fixed-income securities.

The question is, can the Federal Reserve or the ECB (European Central Bank) or the Bank of Japan really do enough to push the needle higher on growth? We would argue that’s not going to be the case. And that leads to the question of the efficacy of central bank policy, which is raising a whole host of issues, such as whether fiscal easing is the next step for some countries.

P&I: Can or should investors tune out those questions about monetary policy? What should they be focused on?

Mark Vaselkiv: Risk-free bonds can serve as insurance policies in the event of a very serious geopolitical or economic problem in the world. Having some risk-free safe instruments, such as U.S. Treasuries or German bunds, provides a level of downside protection in a world where those types of anomalies occur with increasing frequency.

It’s clear that investors are willing to hold onto those types of securities and even this year, notwithstanding the fact that rates have been very low, they’ve still delivered very positive returns. So amazingly, the German bund market has delivered more than 5% year-to-date, and even the five-year Swiss bond has generated positive total returns. So holding instruments able to perform in times of stress remains very important.

And I would also say, as a little bit of a corollary to that point, that central bank policy really has acted like a fire extinguisher during these periods of major volatility. I think the classic example of that would be this summer, when the Brexit vote took the whole world by surprise. Right after that, for the first two or three days, global financial markets lost trillions of dollars and there was a major anxiety attack going on pretty much everywhere. But the central banks stepped in quickly and their moves really put the fire out. The markets calmed down dramatically and we were back off to the races because of that expectation that the fire truck will always show up when something goes wrong.

And so yes, you can talk about negative yields, but if you think about those securities as insurance policies, there is a cost to owning any insurance policy.


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Looking for a Haven? Try Junk Bonds


Fixed-income investors looking for protection from rising interest rates may want to turn to a surprising haven: junk bonds.

It sounds like a bad joke. High-yield bonds, issued by companies rated below investment grade, are loaded with credit risk. If the economy weakens, they fall in price. If recession looms, they plummet.

But if President-elect Donald J. Trump gets his way—a big if—there is little chance the U.S. economy will go into recession in 2017. Stocks have already run up—and bonds fallen—on expectations that his initiatives will lead to lower taxes, lighter regulation, and more government spending. That should mean faster economic growth but higher inflation and rates. In that scenario, moving assets to short-term bonds and whittling back on Treasuries makes sense. So-called bond proxies like real estate investment trusts and utilities look treacherous.

So where is an investor supposed to turn for yield? That’s when an allocation to high-yield bonds starts to look appealing. These bonds yield 6.6% on average and correlate more with stocks than Treasuries. As long as rates rise gradually, the high coupons can compensate for price declines, says James Kochan, chief fixed-income strategist at Wells Fargo Funds. Since the election, investment-grade bonds are down 2.4% and Treasuries are off 2.6%, but high-yield bonds are just 0.23% lower.

Take note: This isn’t a prediction that junk bonds can generate the same double-digit returns next year that they did this year. Thanks to a strong rebound following the commodity-related swoon in February, junk bonds are up 13% in 2016. This is despite a round of profit-taking that started in October when rates first started to rise.

Mid-single-digit returns in high yield seem likely for 2017, several portfolio managers tell Barron’s. That may look pretty good a year from now. Gershon Distenfeld, portfolio manager of the AB High Income fund, has reduced his fund’s high-yield exposure to 50% from 70%, but he thinks the asset class is a better bet than stocks at current prices. “Investors have to brace for lower returns across a lot of asset classes,” he says.

Valuations in high yield aren’t particularly attractive, notes Mary Bowers, a high-yield portfolio manager at HSBC Global Asset Management. “Still, I think return potential looks better than other parts of fixed income,” she says. She is adding more floating-rate securities, including some hybrid ones issued by financials. Bonds rated B, a midlevel rating within high yield, are the “sweet spot,” she says, as they have less interest-rate risk than the higher-rated BB bonds.

Regina Borromeo, head of international high yield at Brandywine Global, is also adding more floating-rate securities, such as corporate loans, which yield around 4%. “It’s a way for investors to get attractive credit spreads without as much duration risk,” she says. She notes that junk bonds with shorter maturities are holding up better than longer-term bonds.

Investors looking to capture yield and eliminate interest-rate risk may want to construct a portfolio of individual junk bonds across maturities, rather
than invest through a fund, says Thomas Byrne, director of fixed-income at Wealth Strategies & Management. High-yield bond-fund prices are likely to fall as rates rise, and high redemptions could make declines worse in a sharp downturn, he notes.

In contrast, investors who hold individual bonds to maturity will most likely get back what they invested—junk-bond default rates run about 5%—and can then reinvest proceeds at higher rates. In such cases, the bond’s yield at purchase becomes the total return, says Byrne. This approach means less opportunity to benefit from price appreciation. But at current valuations and given the outlook for interest rates, such gains are less likely anyway.

SOURCE: Barron’s

Forget Dividends and Buy Corporate Bonds Instead


As investors across the globe search for stability and income, it is becoming more common to see investors shift capital from fixed income securities into the equity market. It should be no surprise that the shift away from the bond market and into equities is heightening the risk profile of many portfolios by reducing the benefits of diversification. Rather than completely abandoning bonds and other fixed income assets, another option could be to consider corporate bonds through various exchange-traded funds. In the article below, we’ll take a look at the patterns and try to determine where prices are headed from here.

SPDR Barclays Short Term Corporate Bond ETF

One of the most popular exchange-traded funds used by investors for gaining exposure to corporate bonds is the SPDR Barclays Short Term Corporate Bond ETF (SCPB). For those new to this type of investing, the fund’s managers seek to provide investment results that, before fees and expenses, correspond to the price and yield performance of the Barclays U.S. 1-3 Year Corporate Bond Index. Taking a look at the chart below, you can see that the fund has been trading along a key ascending trendline, and the bulls have propped up the price on each attempted pullback for most of 2016. Given the proximity of the support, active traders will likely look to set their stop-loss orders below the trendline or the 50-day moving average, which are both trading near $30.71. (For more, see: Top 5 Bond ETFs for 2016.)

iShares iBoxx High Yield Corporate Bond Fund

Another popular ETF used by traders looking for alternatives to dividend paying stocks is the iShares iBoxx High Yield Corporate Bond Fund. The managers of this ETF seek to provide investors with exposure to a broad range of U.S. high yield corporate bonds for a reasonable expense ratio of 0.50%. So far this year the fund has moved higher by 12.21% and based on the chart below, it looks like the momentum could continue. Notice how the ascending trendline and the 50-day moving average have helped act as strong levels of support. Based on technical analysis, this type of behavior is expected to continue and many traders will maintain this bullish outlook until the price closes below $85.14.

iShares iBoxx $ Investment Grade Corporate Bond ETF

For investors who would like to reduce the risk of their bond holdings more than what is offered through the funds mentioned above, one of the most popular options would be the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD). This fund offers investors access to more than 1000 high-quality corporate bonds in one holding and has total net assets of nearly $33 billion. Fundamentally, the low expense ratio of 0.15% also makes this fund appealing to all types of investors and based on the chart below it is trading within one of the strongest uptrends found anywhere in the public markets. Active traders would likely maintain a bullish outlook on LQD until the price closes below $122.88.

The Bottom Line

The global interest rate environment and thirst for yield have led many investors to shift capital from the fixed income market and into equities. Based on the charts of the bond funds shown below, rather than moving entirely into stocks it could be time to add some corporate bonds to your portfolio.

 SOURCE: Investopedia

What are the biggest risks and opportunities for bond investors?


Fixed income managers explain their portfolio positioning following a volatile half year, and how they are taking advantage of opportunities in the sector while negotiating challenges including political uncertainty and ‘lower for longer’ bond yields.

Political risk

The biggest risk to watch out for in the second half of this year is political uncertainty. US presidential elections, the fall-out from Brexit, and the threat of further yuan devaluation could drive volatility in commodity and other risk assets.

Volatility could lead to outflows and, if sustained, a deterioration in the availability in credit. A combination of stressed corporate fundamentals and a lack of credit will ultimately drive defaults upward, but we do not expect to see this in the short term.

The biggest opportunity for high yield investors remains outside the commodity sectors, where default rates continue to track below 1% (well below the historical average of circa 4%), but valuations, despite a strong rally, are still near their long-term averages.

The forecast backdrop of positive but slow growth in the US economy, coupled with continued easy central bank policy, should continue to drive demand and keep defaults in these sectors contained for the rest of 2016.

While increasingly fragile corporate fundamentals inform our relatively conservative positioning within the strategy, credit risk premium is one of the only traditional risk factors that still offer value to investors, making high yield an attractive asset class in a low-yield world.

Brexit concerns

We construct the portfolio on a long term, bottom-up basis and do not position based on the market outlook for the rest of the year.

Despite credit markets shrugging off Brexit, we think this remains a key area of uncertainty going into the second half of the year and beyond. We believe the economic and political uncertainty created by Brexit is a problem for Europe as a whole and not only the UK.

In the aftermath of the vote, we have not made any material changes to the portfolio, though we are actively considering our more economically cyclical holdings, alongside those bond issuers who have relatively near-term debt maturities to deal with.

In both regards, we believe the portfolio is currently well positioned from a risk perspective.


Markets are still trying to make sense of the Brexit aftermath, but one thing is apparent: investors are bracing themselves for uncertainty, and sentiment is negative.

This type of environment is conducive to safe-haven assets, in particular government bonds such as US treasuries and UK gilts. ETF investors have the benefit of gaining precise exposure to such assets across a range of different maturity buckets.

Another area or recourse that has been popular in 2016, and may continue to be so, is credit. In Europe in particular, corporate bond ETFs could be of interest due to the attractive yield pickup and ongoing ECB monetary policy supporting euro corporate debt.

There may be opportunities in inflation-linked instruments. There has been a consistent trend of positive flows into inflation-linked bond ETFs since October 2015, with over $2bn in 2016 alone.

These range from traditional linkers such as inflation-linked gilt ETFs and Treasury Inflation-Protected Securities (TIPS) ETFs, to more innovative inflation expectations ETFs that aim to match the inflation breakeven rate. One reason behind these strong flows is that inflation expectations are on the rise, both in Europe and the US.

SOURCE: Investment Week

Online U.K. Lender Starts Marketing Big Bonds to Small Investors


A startup online lending marketplace began offering retail investors access to individual corporate bonds for as little as 100 pounds ($132) on Monday.

WiseAlpha said its online platform provides potential annual yields of 5 percent to 8 percent and is a “compelling alternative” to low-yielding savings accounts, the stock market or peer-to-peer lending, according a statement. The average yield on investment-grade corporate bonds in euros fell to a record low of 0.71 percent on Thursday, according to Bank of America Merrill Lynch index data.

The company will issue notes backed by individual bonds or loans that it acquires, allowing small investors to access securities typically only available in larger sizes, according to the statement. WiseAlpha charges a 1 percent annual service fee and a 0.25 percent sale fee for investments sold in the secondary market, it said.

“The ability to purchase corporate bonds in small denominations has never before been possible for the private investor,” Rezaah Ahmad, founder and chief executive officer, said in the statement. “Retail investors are often crowded out of retail bond issues by institutional investors and their choice is often limited to financial based companies rather than a broad range of corporates across different sectors.”

Senior secured bonds issued by U.K. companies Enterprise Inns, Vue Entertainment and New Look are among those being offered on the platform, which was created in February. It also provides access to senior secured corporate loans from companies including Virgin Media and United Biscuits.

To achieve the yield target, most bonds will be rated between B and BBB, Ahmad said in an interview. The average yield on speculative-grade bonds in euros fell to a more than one-year low of 4.2 percent on Thursday, according to Bank of America Merrill Lynch index data.

The company wants to appeal to younger investors and people who might only be able or willing to commit a few hundred pounds to an investment at any one time, he said.

“Our ethos is that we want as many people as possible to start using the site and gradually educate themselves over time about these financial instruments,” Ahmad said. “We very much want to liberalize this market.”


SOURCE: Bloomberg

Europe’s Asset-Backed Bond Market Is Growing More Mysterious


Europe’s asset-backed securities market (ABS) is going underground.

Having been thrust into the spotlight after the financial crisis as regulators blamed the products and the bankers that structured them for causing the crash by obscuring risks, the ABS market is retreating further into the shadows.

Private bilateral sales of the bonds, which are typically backed by collateral such as car loans or mortgages, now outstrip public sales to investors, according to Bank of America Corp. analysts led by Alexander Batchvarov.

So-called retained transactions, which are kept on banks’  balance sheets, rose to 78 billion euros ($87 billion) in the first six months of the year, which is more than double the 30 billion euros sold in the same period of 2015, according to Bank of America data. For investors in the public market, new-issue supply totalled just 41 billion euros, or roughly half the volume recorded a year earlier.

Instead of using securitization — the process by which such ABS are created — to provide investors with new assets, banks are using the technique to manage risks and offload assets in private transactions that are typically unrated and where transaction data is often not available.

While many retained deals are destined for use as collateral at the European Central Bank’s liquidity programs, securitization of whole loan portfolios including non-performing loans, is a source of growth for retained deals, according to Bank of America.

Synthetic securitizations, in which credit derivatives are used to transfer risk, are also said to be growing in favor as banks seek to bolster their balance sheets — and even as regulators push back against use of such “regulatory capital” trades.

“Discussions with market participants suggest that the volume may be (much) larger,” Batchvarov wrote. “The revival of synthetic securitisations speak[s] to the need of the banks to manage their capital and credit risk of their balance sheet, but apparently this is now done through bilateral transactions, mostly not rated, and rarely seen.”


SOURCE: Bloomberg

Brexit Could Knock Hole in Covered Bond Market


Brexit could knock a hole in the $1.4 trillion market for euro-denominated covered bonds, if collateral from Britain can no longer be used in European issues of this debt.

In this market, lenders use mortgages, commercial loans and public-sector debt to back payments on bonds. Covered bonds are a cheap form of finance across Europe.

In the European Union, the market is closely regulated by national watchdogs and trade organisations, and their rules set parameters on where the collateral must come from.

With its vote last month, the U.K. may have stepped out of those parameters.

European banks have been able to package U.K. assets into covered bonds on the basis that the country was a part of the European Economic Area.

In Germany’s Pfandbrief market, one of the largest covered-bond markets in Europe, collateral pools of domestic bond issuers include almost €10.2 billion of British assets, according to data by NordLB. Most of those assets are commercial mortgages, export credit and aircraft loans.

The U.K. has voted to leave the EU and may not afterwards join the EEA, which has access to Europe’s common market, given that would mean having to accept free movement of people, a key bugbear for many of those who voted for Brexit.

Lawyers are also asking what that may mean for outstanding bonds that have British assets as collateral.

“Grandfathering is the only practical solution for existing Pfandbriefe featuring U.K. collateral,” said Vincent Keaveny, a partner at law firm DLA Piper.

This could involve authorities publishing guidance that exempts outstanding German covered bonds from collateral location rules.


SOURCE: Wall Street Journal

Alternative income boom here to stay, says Cade


Numis Securities Charles Cade reveals why he thinks recently launched closed-ended portfolios in the alternative debt space should avoid the fate of similarly vaunted vehicles in previous years.

Newly launched investment trusts are more likely to weather potential market headwinds unlike examples in the past, according to Charles Cade (pictured), head of investment company research at Numis.

At times in the past, it has been recently launched trusts – which have usually come to market due to sheer demand from investors wanting exposure to new hot investment trend – that have been the first to be wound up as market conditions change.

The investment trust sector is often praised for its constituents’ longevity with some well-known ITs launched decades (and sometimes more than a hundred years ago) still performing strongly.

However, initial public offerings (IPOs) for popular investment trends have tended to come in waves with many newly launched trusts ending up closed, merged or wound-up. In fact, only about one in four of those launched between 2000 and 2009 (326) have survived in their original form.

One of the bigger trends in the space in recent years has been a spate of launches seeking to provide ‘alternative income’ exposure and 2015 in particular was a bumper year which saw many new portfolio names on the London market.

In the first three months of 2016, however, there has been the lowest number of investment trust launches since confidence tentatively returned to markets in early 2009 from the depths of bearishness induced by the financial crisis.

This was reflection of severe volatility in both equity and bond markets, says Cade, as well as a widening of many discounts, particularly among the nascent alternative income portfolios which raised significant amounts of capital in recent years.

“The lack of IPOs in 2016 to-date could be viewed as a sign that the current phase of alternative income IPOs has come to an end,” he said.

“In our view, however, there remains strong demand for funds that can deliver a predictable yield, as reflected by the number of secondary issues that are still taking place. There is inevitably a threat that the appeal of some mandates will wane once interest rates start to rise, as this is likely to lead to a shift in asset allocation by investors.”

Number of annual invesmtent trust IPOs since 2000


SOURCE: Trustnet

Savers could earn better returns over next year by using fixed-rate bonds to protect against falling interest rates


Savers could earn an extra £50 over the next year by using a fixed-rate bond to protect against falling interest rates.
Last week, Mark Carney, governor of the Bank of England, hinted that the base rate could drop to 0.25 per cent.
The cut could come as soon as next week, after the meeting of policymakers – though some experts think the bank might wait until August.

For years, savers have turned their backs on fixed-rate bonds in favour of easy-access accounts as they wait for the base rate to rise from its historic 0.5 per cent low.

In the past two years, they have pulled a huge £40 billion out of bonds.

But that strategy has been turned on its head now that we are on course to leave the EU.

In a fixed-rate bond, you are cushioned from any fall in rates, whereas with easy-access accounts, you are at the mercy of banks and building societies, which are highly likely to cut your rate, too.

Giles Hutson, chief executive of Insignis Asset Management, says: ‘Interest rates are going to stay lower for longer following Brexit. If you are comfortable locking up your money, fixed-rate bonds make a lot of sense.’

Patrick Connolly, an independent financial adviser at Chase de Vere, says: ‘The long, hard slog for savers continues. If the base rate is cut, savings rates are likely to fall, too. If you are happy to tie up some of your money, stick to a one or two-year term.’

However, before you fix, you must weigh up how quickly inflation will rear its head.

The fall in the value of the pound following Brexit means things we import from abroad are more expensive – and this will work its way through to what we pay for goods and services.

Then, the Bank of England is highly likely to raise rates to keep the lid on the rise in the cost of living.

But even in the unlikely event that base rate reaches 1 per cent in 12 months’ time, fixed-rate bonds are the better option.

The top easy-access account from internet bank RCI pays £145 a year on each £10,000.

But you can earn £179 with Charter Savings Bank’s one-year fixed-rate bond.

A base rate cut of 0.25 per cent next week could bring the RCI Freedom account rate down to 1.2 per cent.

If base rate rose to 1 per cent after six months – and your easy-access rate rose immediately in line – you would still be better off with the fixed-rate bond.

The 0.75 percentage point rise in base rate could bring your easy-access deal up to 1.95 per cent.

Six months at 1.2 per cent and 1.95 per cent a piece would bring you in £157.50 – £60 in the first six months and £97.50 in the second.

It’s the same in the High Street, where the top easy-access rate is 1.26 per cent from Virgin Money Defined Access, if you make only three withdrawals a year.

Using the same scenario above, your total interest with this account is £138.50. While in the High Street’s top fixed-rate deal, Co-op Bank Britannia Bond, you would earn £150.

The top two-year fixed-rate deals are 1.91 per cent from Charter Savings Bank and 1.9 per cent from RCI Bank. Virgin Money and Leeds BS pay 1.4 per cent in the High Street.

If rates rise to 1 per cent in six months’ time, you will be better off in the Virgin Money Defined Access account, with £314.50 interest over two years against £300 in Co-op Bank’s bond.

But if rates stay lower for longer, the bond will prove the better choice.