I saw some startling statistics the other day. According to Goldman Sachs Asset Management, $13trn in global debt now trades at sub-zero yields and one-fifth of European investment-grade debt is trading at negative yields. 
A decade on from the global financial crisis and monetary normalisation still seems to be a distant dream. Only the Fed has managed to give rising interest rates a real shot and even that has been muted. The market had been pricing in a further three-to-four interest rate rises as recently as three-to-six months ago – today it is pricing in three-to-four cuts. And other countries have responded: in the middle of 2018 40 central banks were raising rates whereas 20 – mainly those with currencies pegged to the US dollar - are now cutting them.
In Europe, expectations have changed too. Mario Draghi is still having to “do whatever it takes” in his seventh and final year as president of the European Central Bank. His speech a couple of weeks ago was very dovish and now markets are expecting a rate cut this month and perhaps more QE (quantitative easing) – a stimulus programme that was only stopped in the final quarter of 2018.
As Chris Higham, manager of Aviva Investors High Yield Bond fund, pointed out when we spoke to him, Draghi’s change of heart was something of a surprise: while a couple of European countries are flirting with recession, the data isn’t that bad and the intervention – based on slowing growth – seems a little premature. But markets, addicted to QE as they are, loved it. Equities and bonds alike have rallied.
So with slowing growth and below-target inflation, the current low (to negative) interest rate environment is likely to be with us for longer.
The implications of this, in the fixed income world, is that European investment grade and government bonds should benefit from more buying from the European Central Bank. Will it go as far as buying high yield? It’s possible: Japan is the precedent after all and its central bank is buying most assets, including equities. Only time will tell.
What we do know for sure is that the hunt for yield is keeping investors in the higher-yield, riskier end of the market. Is this a good thing if the cycle is coming to an end? It’s not necessarily a bad thing. QE, as we know, has floated all boats. And it has also made default rates fall.
Over the past 50 years, the global default rate averaged 4 per cent – over the past decade it has been 1-1.5 per cent. Companies can still borrow money at very low levels.
But care is required. Another point made by Chris was that European and UK companies have been more prudent in terms of balance sheet management. In contrast, the US has been more intent on returning money to shareholders and balance sheets have deteriorated.
Chris has been running the Aviva High Yield Bond fund since November 2012. One particular anomaly that he is using to find opportunities is the much-unloved British pound. Debt issued by European and US companies in sterling has much higher yields than the debt in euros or dollars, as no one wants to own sterling assets at the moment. So you can own the same company’s debt but get better income returns. The fund currently yields 5 per cent.
Sector-wise, he favours financials (12.9 per cent) and communications – in particular, telecomms (21.1 per cent). With sterling bond yields of 6-7 per cent for the likes of HSBC and Barclays, the opportunities are clear. The fund also has an extremely low default-rate, which is a testament to Chris’ stockpicking skill and his focus on management teams that are incentivised to strengthen their companies’ balance sheets. It has returned 122.1 per cent over the past 10 years (to 9 July).
Another fund in this sector I like is Baillie Gifford High Yield Bond, which has been run by Robert Baltzer since 2010 and is now co-managed by Lucy Isles. Like the Aviva fund it offers investors access to a portfolio of predominantly UK, US and European high yield bonds. The managers for resilient businesses that can survive the full business cycle and have the ability to improve their financial health. They back their ideas with conviction and give them time to come to fruition.
The yield on the fund is currently 4 per cent and it has returned 150.9 per cent over the past decade (to 9 July).
If you want exposure to emerging rather than developed markets, M&G Emerging Markets Bond is worth a look. Run by the highly experienced and skilled Claudia Calich since December 2013, it has the flexibility to invest in both emerging government and corporate bonds, denominated in local or hard currencies. Claudia analyses the macroeconomic environment, and individual companies, to pick what she believes to be the best mix of bonds for this portfolio. At the moment it has almost 70 per cent in government bonds: 26.6 per cent in local currencies and 43 per cent in hard currency. The yield on the fund is 5.5 per cent and, over ten years, it has returned 141 per cent (to 9 July).
Darius McDermott is managing director at FundCalibre. The views expressed above are his own and should not be taken as investment advice.