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Limited potential seen for bonds but Finns turn positive

US government bonds offer the most reasonable yields according to Invesco but only Finnish selectors are keen

Drop unconstrained bond sentiment

Fixed income only offers a limited return potential according to asset manager Invesco, with only Finnish selectors in Europe warming towards developed market government bonds according to the latest Last Word research.

Invesco managing director – head of multi-asset research, Paul Jackson, told Expert Investor that there were some opportunities in fixed income despite low yields, the US Federal Reserve raising rates, and big central banks no longer being big buyers of assets.

“The Fed is the one major central bank that is consistently raising rates (though we believe it is possible that the European Central Bank (ECB) will have started by the end of 2019) and Fed actions tend to drive global bond markets,” he said.

“Another factor that we believe will force global yields higher is the cessation of central bank asset purchases. As recently as 2016, the aggregate balance sheet of the Fed, ECB, Bank of England, Swiss National Bank and Bank of Japan were growing at a 20% year-on-year rate.

“However, we expect it to start shrinking over the coming months as the ECB stops buying at the end of the year and Fed balance sheet reduction outweighs BOJ asset purchases.”

Jackson said this would limit the return on global multi-asset portfolios, with bonds particularly vulnerable as they were the target of most central bank purchase activities.

“As the Fed continues to tighten, we believe the future cyclical average will be only 3.5%. This suggests medium term annualised returns will be close to the current yield,” Jackson said.

US government bond opportunity

Jackson noted that US government bonds offered a reasonable yield though he expected yields to increase.

According to Bloomberg, US Government 10-year bond yields are currently at 3.2%.

US generic government 10-year yield

Source: Bloomberg

“The yield on US high-yield is 7% but we expect that to rise to around 9% in the medium term and, allowing for default rates in line with historical norms, we project an annualised return of around 4% (over five years).

“Unfortunately, the returns that we project on other developed markets are much lower and, we believe, are largely uninteresting.”

Finnish selectors against the grain

However, pan-European fund selectors do not feel the same way as developed market governments are highly unfavourable, according to Last Word Research.

Despite this, the asset class’ sentiment has also been following an upward trend since Q1 2017.

[visualizer id=”8222″]
Source: Last Word Research

“Average demand for developed govvies has crept up for the second quarter in a row. It is still net negative, meaning sellers outnumber buyers, but the upward trajectory is of interest,” the quarterly asset class survey said.

“Around 10-20% of respondents expect to add to their allocations but are mostly overshadowed by the sheer number of sellers.”

According to Morningstar, the asset class has attracted inflows of €6.3bn since October 2017. September experienced outflows for the first time since January at €577m.

According to Last Word Research Finnish selectors turned positive to developed market government bonds in Q3 for the first time this year ranking the asset class 11th out of 26 while for selectors across the rest of Europe the asset ranked 25th.

Among the Finnish selectors, 21% looked to increase the asset class, 11% to decrease their holdings, 53% to hold, and 15% did not use the asset class.

[visualizer id=”8223″]
Source: Last Word Research

This was compared to pan-European selectors’ allocation that had 13% looking to increase the asset class, 33% to decrease, 40% to hold, and 15% did not use the asset class.

[visualizer id=”8225″]
Source: Last Word Research


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