Investors should think twice before jettisoning fixed income exposure despite a bad first six months of 2015 due to the likelihood of further monetary easing from the world’s leading central banks, according to Ken Leech, chief investment officer at Western Asset.
Bond markets have started to wobble in 2015 as the prospect of an end to a multi-decade rally in fixed income has been more widely predicted, most notably following a huge spike in government bond yields in May.
Performance of indices in 2015
Source: FE Analytics
Leech, who oversees the $400bn of total fixed income assets under management at Western Asset, says he is expecting fixed income to pick up in the second half of the year as central banks move to further ease their monetary policies – including further quantitative easing.
“We believe that this recovery is going to go forward and that is the basic underlying theme, although we do think it is going to be an uneven process and a slow process. It is going to demand a lot of central bank help and we think that kind of help is going to have to continue and stay with us. We think you will see a continuation of stimulus,” he said.
“The Fed wants to raise rates: they want to get off zero and we are likely to see them do so in the second half of the year, probably in September. There is no inflation impediment to the Federal Reserve, the Bank of Japan, the European Central Bank and the Bank of China to do very aggressive easing – that is what we are seeing and that is what will continue. We think that is what ultimately means we are very positive for the second half of the year.”
“The ECB have promised to get their balance sheet up to where they were in 2012 and they have built an enormous political coalition in order for them to have the ammunition to do this. We do not think they will back off, we think they will accomplish this goal which means you will have an awful lot liquidity coming into the market from their direction.”
Leech adds that while interest rates will undoubtedly rise during this period, it will not knock back markets as many participants currently fear.
“You are going to see a very, very cautious interest rate path. We are very aligned with the recovery trade. However we do think US economic growth will be pretty moderate. There is some risk to the downside and we are a little nervous to the downside. The bounce back in the US economy has not been as we hoped,” Leech said.
The $4bn Legg Mason Western Asset Macro Opportunities Bond fund is one of Western Asset’s – itself the largest affiliate of Legg Mason – biggest funds available to UK investors.
It has outperformed its sector considerably since launch in October 2013, returning 17.25 per cent compare to an FO Fixed Interest average of 4.59 per cent, although it has seen greater volatility than average fund in the sector.
Performance of fund and sector since launch
Source: FE Analytics
However, it has sold off harder than the sector average since markets started going down in January but has kept a top quartile position thanks to a strong 2014.
Meanwhile, James Harries, manager of the Newton Global Income and BNY Mellon Global Higher Income funds, strikes a different tone when discussing the future of central bank action.
“Overall, Newton is maintaining a cautious stance owing to an ongoing questioning of the efficacy of monetary policy, the effects of which are likely not to turn out as everyone expects. This is in part due to one of our investment themes ‘debt burden’, which along with other factors such as demographics will result in economies struggling to grow,” he said.
“With regard to QE, it is highly possible that it will turn out to be deflationary. It has resulted in a distortion in the price of assets. This distorted pricing structure sends the wrong signals to the economy to build capacity to service a level of capacity which itself is artificially stimulated. Attention is often directed towards the demand encouraged by QE without considering the supply response from the economy. In essence there is too much capacity and not enough demand.”
Anna Haugaard (pictured), fund research analyst at Brewin Dolphin, says investors have started dumping European fixed income in favour of equities.
“Last week’s bond market turmoil saw investors abandoning the asset class while European equity funds saw positive inflows. The reversal that many thought was a long way off has clearly shaken vast swathes of investors who banked on the ECB’s commitment to QE,” she said.