This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, David Arnaud, senior fund manager at Canada Life Investments makes the case for global bonds amidst rising interest rates.
Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, David Arnaud, senior fund manager for Canada Life, explains why rising bond yields have changed the investment paradigm
Earlier in February, a surge in inflation expectations in the context of strong global growth, combined with central banks hinting at upcoming additional rate rises caused a spike in government bond yields globally. 10-year yields have risen since the end of 2017: US Treasuries are up from 2.41% to 2.85% at the end of March.
This has caused a selloff within fixed income as an asset class, with many commentators now speculating that we are finally at the end of a long bull market in bonds. This speculation is to be expected, as we are all aware that we are entering a period of rising interest rates, following a decade in which they have been at rock bottom. However, it has ignored some subtle but important points.
Fixed income markets have been volatile, but they have actually held up better than equities. As an example, since the end of January global equities have fallen by more than 4% in local currency terms. Global bonds are down just 0.8%, as of the end of February. This has been due to concerns over the pressure rising rates may put on highly valued growth stocks, alongside uncertainty surrounding the inflation outlook, despite the synchronised global economic recovery that we have been witnessing.
Ultimate Risk-Free Asset
In addition, rising yields change the investment paradigm To take an example from the US, 2-year Treasuries now yield more than the dividends received on the S&P 500 Index, which suddenly makes them a more attractive investment proposal in the eyes of many market participants. Would they prefer the ultimate risk-free asset with a 2% yield, or a potentially volatile ride in an expensive equity market?
As a result, there is still a significant demand for fixed income assets, even within a rising-rate environment. A demand that we believe is healthy and which should continue to support the asset class, regardless of the underlying environment. However diversification remains important within each asset class held in a portfolio.
A top-down approach to setting interest rates and macro forecasts and a bottom-up approach to setting credit exposures can serve a bond manager well. For example, during the recent market-sell off, corporate bonds have outperformed their government counterparts and an overweight here has been beneficial, as has exposure to the Eurozone. In this low-but-rising rate environment, holding the appropriate mix of currencies is essential as it can substantially add to total return. A diversified, actively managed global bond portfolio can add value in all market environments.
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