 Quantitative easing (QE) has deeply distorted the fixed-income market. Low interest rates have certainly increased the investor appetite and search for yield but has the policy simply masked underlying market weaknesses? Whilst volatility may have created opportunities for active asset management, what impact will it have on the traditional sovereign bond market?
The ‘Investing in Fixed Income, Europe’ report released by Clear Path Analysis in collaboration with Royal London Asset Management (RLAM) and Newton Asset Managers, debates the ‘great rotation’ and examines both fixed-income’s remaining potential and the market’s latest product solutions.
Reflecting on the long-term significance of QE Ian Kernohan, Economist, Royal London Asset Management, states that: “The Bank of England now holds c.30 percent of the sovereign debt market, and as a result, quantitative easing (QE) has led to a significant change in the size and composition of its balance sheet.”
Concerns that nominal spending was too weak to meet inflation targets resulted in this current QE. According to Kernohan; “Ultra low interest rates have encouraged financial institutions to increase risk in a “hunt for yield.” {…} The effect has been to push the price of some assets beyond their fundamental value, and the longer the policy has been in place, the more complacent markets have become about an eventual exit”
Paul Rayner, Head of Government Bonds, Royal London Asset Management, concurs: “Whilst QE is distorting yields in one aspect it has made risk assets more attractive and we are seeing certain asset classes being pushed to valuation levels which are extreme.”
As to how investors should respond to hyper-inflation fears Rayner advises: “We feel that by being opportunistic and not wedded to a bond index is probably the right way to go. You need to be able to manage the duration risk and shouldn't be dictated to by the market cap weighted of the index but equally you should be as global as possible and diversify your interest rate currency risk.”
For Nick Wheeler, Chairman of Trustees, Volvo Group UK Pension Schemes, “You cannot escape the disproportionate effect QE has had on scheme liabilities. The question of its withdrawal is a wider one as it depends on how markets are at the time”
Given the depressed nature of long-term yields Scott Freeman, Portfolio Manager, Nationwide Pension Fund, suggests: “One option has been to move down the credit curve to pick up additional yield but given where absolute rates are this is not terribly attractive. The central banks have got a difficult job on their hands in how to take this artificial support away, it is a tricky balancing act.”
For Mohit Kumar, MD, Fixed Income, GLG Partners; “…a lot of the in-flow that we have seen is investors moving from these long end fixed income products into front end fixed income products with the idea that central banks will be behind the curve.”
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