Paul Brain, manager of the Newton Global Dynamic Bond Fund, looks at the investment environment for global fixed income investing and the emerging opportunities that are catching his eye
-High debt levels are supportive of fixed income markets, but such an environment is also disruptive
-Investors are reluctant to invest as fears of a Eurozone collapse or Chinese economic weakness dominate their thinking
-We believe that those markets which offer the best risk and reward benefits are to be found in the emerging markets
"Fixed income markets have undergone remarkable changes over the last three years," says Brain. "Tight fiscal policy is supportive of fixed income markets, as it results in low interest rates and also helps to keep a lid on inflation. However, we believe that such an environment is also disruptive, as it raises the possibility of default by both companies and governments.
"The response from the authorities - struggling to cope with the negative effects of deleveraging - can have a significant influence upon markets, especially in the short to medium term," he explains. "Whether these authorities resort to the maintenance of very low interest rates, money-printing or default, all such possible responses have caused significant concerns among investors, and have changed the fortunes of global bond investors. "
"Due to the constant concern about a possible collapse in the euro or a sharp slowdown in the Chinese growth story, we believe investors have been, quite simply, reluctant to invest," says Brain. "Concerns have, more recently, been offset by the provision of funds through central bank operations, most recently in the form of the European Central Bank's 'LTRO' (Long-Term Refinancing Operations). While disaster appears to have been averted, the liquidity these funds have provided seems to be flowing into financial assets instead of the real economy. We expect the current strong appetite for risk to continue at least until the effects of the most recent LTRO programme have worked their way through the system. A weakening economic environment could return as a significant concern to investors once the effects of that programme have waned," he warns.
Diversify and conquer...
"Bond indices are built on market capitalisation (i.e. the amount of an issuer's debt outstanding), which has the effect of steering the investor to the markets where, historically, there has been the greatest issuance," explains Brain. "These are not, however, the markets that we believe are likely to have the best returns. In our view, some of the markets that offer better risk and reward benefits are actually to be found in the emerging markets. Here, we are talking about countries that have improving credit rating support and also the flexibility over monetary policy. Since 2000, seven large emerging market countries have achieved investment-grade ratings (Brazil, Colombia, Peru, Panama, India, Mexico, and Russia)," he adds.
"At present, our portfolios reflect a more favourable attitude towards risk markets through greater emerging market exposure and a more diversified currency exposure, rather than through holding peripheral European debt." He continues, "We remain concerned about the approach to the Eurozone crisis, which subjects already weak economies to fiscal austerity. A prolonged period of recession in parts of Southern Europe will continue to shift the emphasis of the crisis from one focussed on liquidity to solvency concerns," Brain warns.
"While we believe, ultimately, that investors in Italian and Spanish government debt will be spared a ‘haircut', we think that we may be likely to see Greece exit the single currency, as well as a Portuguese capital impairment (a reduction in the payments due to investors in the country's government bonds)," he says. "We, therefore look to minimise exposure to countries that give rise to unease about financial sustainability," Brain concludes, "and seek instead investment opportunities in countries with stronger fundamentals and a positive long-term outlook."
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