“The biggest risk to the portfolio is unorthodox monetary policies implemented since the financial crisis creating a significant acceleration in inflation,” Singapore-based Delomier told FSA.
“It’s not a big near-term risk, but is probably a question mark that many fixed income investors ought to have. What are the long-term implications of these monetary policies, which are a significant break from the traditional monetary policy?”
Of lesser concern are several recent defaults in Singapore in the energy sector, which could prompt investors to avoid or sell off bonds in less stable economies.
Delomier said he sees no signs of contagion.
“If you had a serious sign of contagion you would expect it to be reflected in the broader Asian credit index, which doesn’t seem to be the case right now. If anything, Asian credit indices have been tightening quite significantly, high yield or high grade.”
Reform agenda play
Capital Group’s global fixed income funds are invested in sovereign or quasi-sovereign global emerging market bonds. The funds include pure US dollar sovereigns, such as Brazil and Mexico, some local currency EM debt or a blend of the two.
“We are focused very much on country and industry selection and company level research. That’s where we’ve got the most insight.”
Currently, value is found in selective investments in emerging markets where serious reforms are underway.
“The pain of not reforming has become worse than pain of implementing reforms. Argentina is an example. It had been poorly managed, but now [president Mauricio] Macri has a more orthodox framework for the medium-long term, so we are invested there.
“Another example is India. There seems to be greater focus on inflation and attracting foreign capital. Everything may not be running smoothly, but we consider it an interesting opportunity in the medium-long term.”
China, which also has structural reforms underway, is not part of the investment universe. Delomier said investments in RMB bonds have been largely avoided due to concerns about corporate governance. The firm also hesitates because the RMB is expected to depreciate further, though in a more measured way.
“It is interesting that at the beginning of the year, the world focused on the RMB depreciating 3-4% and panicked. In the last few months, the RMB depreciated 3% and no one even noticed.”
Capital Group’s products have some exposure to European and Japanese bonds that have negative yields, he said. Negative rates have a big impact on bond investments because portfolio managers use benchmarks that can include a large portion of negative yielding bonds.
“In some instances, there is no choice. Look at the dynamics of the German bund market. Yields are very low but you still have attractive returns. It is difficult to argue that is sustainable long-term, but it’s part of the investment universe and we’ve got to consider it. It is really hard for portfolio managers to guard against buying negative interest rate bonds.”
Credit caution
The firm is careful about credit investments, Delomier said. As a consequence of what he calls the “unorthodox monetary policies” of central banks, credit markets have rallied globally but the credit quality of many corporate issuers has weakened.
“Many years of very low interest rates and unorthodox monetary policies, has given an incentive to a lot of corporate issuers to do shareholder-friendly activities such as mergers and acquisitions and share buybacks. That supports equity prices, but as a bondholder the underlying trend is an increase in the degree of leverage and we don’t look favourable upon that.”
However, he mentioned selective credit opportunities in companies that have already done deleveraging. One example is the pharmaceutical industry.
“There are companies that increased their debt level to acquire competitors which we think have a sound strategy to reduce leverage over time. In a less cyclical industry, they have the ability to generate cash flow required to deleverage,” Delomier said.
