Principal Global Investors, with USD380 billion under management, is urging investors to consider non-traditional tools for investing in fixed income, to maximise returns in the current low yield environment.
The firm finds that several factors, including the decision of the European Central Bank (ECB) to start purchasing investment-grade corporate debt, will likely accelerate the downward pressure on corporate credit yields. At the same time, investors are struggling to find yield opportunities without increasing their risk exposure. The firm writes that the recent actions from the ECB, which will keep yields lower for longer, will make it harder for European investors to reach their return targets.
“However, the combination of policy tightening in the United States, disruptive divergence among asset classes and changes to the inbound bond market purchase in China have also opened up opportunities for those investors that want to continue allocating in the fixed income space”, says Mark Cernicky, Managing Director, Global Fixed Income at Principal Global Investors.
Principal Global Investors’ Global Fixed Income team has identified four credit strategies that may help European investors. The first is lightly managed target duration US credit strategies. The firm writes that the US credit component means that these strategies can offer significantly higher yields than European investment grade bonds by holding on to the bonds to maturity rather than trying to generate alpha from total return opportunities. A key attribute is that the maturity of targeted duration credit is between three and five years, and the lightly managed approach means that the turnover is lower (less than 10 per cent per annum) and designed to harvest the yield of the bonds.
The second is US municipal bonds. The firm writes: “Many US municipal bonds provide higher yields than German Bunds and US Treasuries, for example, and they do not have high correlations to other fixed income asset classes. In addition, they have significantly lower default rates than the corresponding rated corporate debt.”
The third is US mortgage derivatives which have no exposure to corporate credit risk and are a non-credit option for those who fear the end of the credit cycle. They can be structured to have attractive yields with low sensitivity to rate changes, offering increased protection to investors, the firm writes.
Finally, the firm suggests opportunities created by recent regulatory shifts. “Despite the negative performance of bank stocks, bonds and capital securities, the ECB appears to remain committed to providing banks the tools to protect earning capacity by allowing them to borrow from the ECB at negative lows. This is good news for banks and, when combined with the higher capital needed by banks, good for bond investors, who are able to earn attractive returns from strategies that invest across the capital structure of global banks. In addition, changes in-bound Chinese market now allow investors to earn one year yields of over 1.80 per cent by investing in government –guaranteed debt that has been currency hedged.”
Cernicky says: “At first glance, it may appear logical to add more risk to the portfolio in order to achieve yield but we believe that this is not necessarily the case. Thinking about less traditional credit strategies might provide investors with the income they need to meet their targets while maintaining the same, or lower, level of risk.
“We have already seen rising interest from both European and Asian investors. Japanese investors in particular increased their allocations to U.S. municipal bonds following the Bank of Japan’s negative interest rate policy adoption in January. We expect European investors to follow suit and also benefit from additional opportunities in the credit space.”