Gilts Look Attractive But Steer Clear of German Bunds, says AXA

It's very difficult to justify German bunds that yield 0.15% for 10-years, says AXA's Nick Hayes

Emma Wall 25 May, 2016 | 11:41AM
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Emma Wall: Hello and welcome to the Morningstar Series "Why Should I Invest with You?". I'm Emma Wall and I'm joined today by Nick Hayes, Manager of the AXA Global Strategic Bond Fund.

Hi Nick.

Nick Hayes: Good morning.

Wall: Strategic and global which means you can look pretty much anywhere and everywhere for growth for investors. Which is just as well at the moment, because the world is not giving you very many options. Perhaps we'll start with the markets where rates are rising and how that impacts your portfolio. U.S. probably going to go again around June, July, is what most people think. And then in the U.K. probably not until next year now. But both of those are in a rising interest rate environment.

Hayes: Yeah, absolutely I mean there is clearly issues around the outright level of government bond yields at the moment. They are very low on a historic basis. They don’t look great value compared with equity yields or even credit yields. We still think that the place for government bond yields, if you look at this year for example the number of interest rates priced into the market six months ago was way more than we got now.

And suddenly the returns on government bond yields are being quite attractive, because again 2016 like so many years before you've priced in lots of interest rate rises, but actually you've got much less. I think that’s kind of the world we live in now for the next few years, expectations might get ahead of themselves, but they'll probably be dragged back. Actually I think there is a place for government bonds despite being quite expensive in the portfolio.

Wall: I suppose one place that you wouldn’t want to buy and stay issued bonds would be Europe and indeed Japan where we are moving into negative rates and perhaps even further negative. How do you invest in those markets or do you just say actually I don’t want any geographical allocation to that region?

Hayes: Very little geographic, it's very difficult to justify why you would have German bunds that yield 15, 20 basis points for 10-years. So it difficult to make an argument there. That being said just under a year ago we probably invested in long dated German bunds that are probably up 20 points in that period.

That’s a huge return for something that started the year with relatively low. So it's starting to rotate after the government bonds in Europe avoiding negative yielding assets, but there are two options you either go into credit or you go into long-dated or even core sort of U.S. fixed income. We're buying long-dated treasuries as a bit of hedge against also buying lots of credits and high yield which I think is much more attractive.

Wall: Within that corporate sector, there is business issue debt. Are there any sectors that are looking particularly attractive or is very much an issuer-by-issuer case?

Hayes: It’s a bit of both I mean you've had big issues in the last 12 months around the commodity related sectors. So the U.S. high yield market had a difficult 2015, as businesses and investors start to reprice, people's expectations for where oil and other commodities would be. Expectations got way too bearish, so people started talking about $10, $20 a barrel. Needless to say as the market got too bearish and I think sold off too much. 2016 has been great year so far for U.S. high yield. So we have made good money, out of core U.S. high yield but also some of the commodity related names.

So some of the energy sector, some of the sort of oil and gas names have done really well. As again people's expectations for oil got too low, it's now coming back up and its now maybe people thinking $40 or $50 barrel rather than very bearish $10 or $20 a barrel.

Wall: You have alluded to quite a lot of uncertainty in the market. How does that affect duration? Do you think actually hedge your bets and go for long because who knows what's going to happen or indeed the opposite.

Hayes: We've actually been doing exactly the former at the moment. As a bit of hedge not because they are cheap assets but we've been buying long-dated treasuries. Partly because we think investors again will be buying longer dated assets as the short dated stuff is such a low yield. But also in terms of portfolio construction, if you buy long dated treasuries for me that means it allows you the risk budget to go and buy high yield, go and buy emerging market. So I think as a portfolio construction tool and I think long-dated treasuries not always the most popular but I think it's quite an interesting asset class.

Wall: Diversification and risk management.

Hayes: Absolutely.

Wall: Nick thank you very much.

Hayes: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar