Developed market government bonds are the worst possible holdings for investors looking to generate income, according to JP Morgan’s Bill Eigen. 
The manager (pictured), who runs the JPM Income Opportunity and JPM Income Opportunity Plus funds, says investors should instead be focusing on high yield credit, which has shown resilience in previous rate hikes and has been further helped by the improving US economy.
“Investors seeking fixed income opportunity must take into account today’s regime of ultra-low global yields and weak market liquidity,” he said.
“With the Federal Reserve moving towards an interest rate hike and the dramatic reduction in trading capacity, investors need to redefine what constitutes value and safety as well as when and how to deploy capital into markets distorted by multiple rounds of quantitative easing.”
The manager says government bonds, which are viewed as traditional and safe fixed income assets, have now become riskier than ever due to price-insensitive buyers such as central banks pushing their valuations to all-time highs.
Performance of sectors in 2015
Source: FE Analytics
“To negatively impact the market such buyers do not need to turn into sellers, but simply decelerate their rate of purchases,” Eigen continued.
“We don’t pretend to know what trajectory central bank policy globally will take and think it is extremely precarious for investors to link an investment strategy to the words and promises of central bankers.”
The manager is also not positive on generic investment grade credit due to impending rate rises and the effect this will have on the fixed income asset, explaining that it is simply not able to cushion market volatility caused by investors adjusting to the reality of higher rates.
Eigen, who currently holds a substantial 40 per cent cash weighting in his JPM Income Opportunity fund, has been renowned for his bearish outlook on fixed income for a considerable amount of time.
In August last year, he told FE Trustnet that the then-strength of the bond market was a false dawn and that he expected prices to begin falling.
“Surprisingly strong fixed income markets have made investors complacent towards risk,” he explained.
“This is a mistake. It is short sighted to believe that rates will inevitably remain low and investors need to be seeking diversification from traditional fixed income.”
While Eigen has remained cautious on government bonds for a long time, other fixed income investors have been following suit this year and are also turning to high yield credit for greater cushioning against rate rises.
This includes JP Morgan’s Nick Gartside, who told FE Trustnet earlier this year that the broader movement in government bonds has created opportunities in high yield corporates.
He explained that European lending conditions were particularly positive and that high yield typically performs well in the current environment, with European companies now growing at their fastest rate since 2009.
“There is a risk that volatility in rates markets has a knock-on effect in the real economy but we point out that the spread between government bonds and lending rates in the real economy looks large by historical standards. We remain constructive on European and US high yield,” he said in June.
Eigen, however, is currently seeing the best high yield opportunities in areas of the non-agency mortgage market that move with home price appreciation as opposed to inflation reports or global risk-off sentiment.
“A steady housing backdrop supports pockets of the securitised market. We see value in the non-agency mortgage market. Housing market data is coming in strong, with home price appreciation up 4.9 per cent over the last year,” he explained.
“The sector’s steady income, low correlation to risk markets and modest rate sensitivity are all attractive. As this market is less frequently traded, investors with an ability to provide liquidity are well positioned.”
Performance of sector vs index in 2015
Source: FE Analytics
Also within real estate, the star manager is seeing attractive opportunities within private commercial real estate lending which, if investors carry out careful due diligence, can access yields of up to 7 per cent.
However, he is still seeing areas of the fixed income market in addition to government bonds that he remains bearish about and is short emerging market debt due to the impact that the collapse in commodities has had on the region.
“This, as well as modest global growth, a weaker China, Fed tightening and a strong US dollar, will all be headwinds for most emerging markets. Considering the relatively low compensation, we do not feel the risk-return is attractive,” he said.
Because of the volatile and high-risk market at the moment that has been magnified by impending rate hikes, Eigen notes that the high yield sector, while being safer than emerging market debt or developed market sovereign bonds, is not homogeneous and needs a stock-picking approach.
“Disciplined, security-selection-oriented investors will be rewarded as the bid for the sector re-emerges in a world starved for income,” he said.
“Key sectors are not driven by fundamentals today, but by the wild card of central bank activity. This includes all developed market sovereign bonds, especially those trading at negative yields.”
Over Eigen’s eight-year tenure, JPM Income Opportunity has returned 33.39 per cent, outperforming its offshore peer group composite by close to 4 percentage points.
Performance of fund vs sector over management tenure
Source: FE Analytics
The £4.4bn fund, which has an FE risk score of just eight, has a clean ongoing charges figure of 0.7 per cent.