Norman Villamin, Union Bancaire Privee
In the past, people generally viewed fixed income as a low risk investment compared to equities.
But fixed income is unusual today in the sense that the emphasis is more on managing risk instead of seeking return or income, Villamin, who is based in Zurich, said at a recent media event in Hong Kong.
Successive years of central bank policies brought down interest rates and made cheap credit readily available. “Now fixed income has become a place where you should focus more on managing risk, both interest rate and credit risk,” he said.
However, even investors who are willing to take the risk and invest in fixed income are not well-compensated for it, especially in European high yield bonds, he said.
In 2017, European high yield portfolios dominated the annual top-ten best performing fixed income funds available for both Hong Kong and Singapore investors, FSA’s research has found. The leader among the European high yield funds delivered a 21.4% return for the year.
However, Villamin is put off by the risk/reward proposition. “In European high yield bonds, you are not getting paid for the kind of risk you are taking. We choose not to own any of them.”
Pictet Wealth Management’s David Gaud sees the underlying risk created by the regulatory changes. He said an “unhealthy and artificial” balance of demand and supply within the European high yield bond market might also turn into a liquidity risk.
“Although volatility sounds unusual in bond market, when it comes to crisis, it could be as big as on the equity side,” Gaud said. “[When] everybody runs for the exit, it could really hurt.”
Low returns for US HY?
Apart from euro high yield, UBP’s Villamin said the risk-return proposition in US high yield is also unattractive due to a low spread. Currently, spreads of US high yield bonds stand at around 340 basis points.
Historical statistics show that bonds with a yield spread of 240-349 basis points have generated far lower returns on an one-year horizon, on average of -7.1%. The probability of generating a positive return from bonds is only 22.7%, versus 79.2 % with spread of 350-539 basis points, he said.
He had a more positive view on Asia bonds.
In Asia, there has been a rotation from US dollar-denominated bonds to Asian local currency bonds as they have a comparatively bigger spread which enables higher returns. These bonds also remain relatively cheap in the cycle while providing a more attractive risk-reward profile for bond investors, Villamin said.