Time to view bonds in a portfolio context

Bond yields may be at historic lows, but the debate surrounding the asset class frequently misinterprets the role that fixed income plays for most investors, believes George King, head of portfolio strategy at RBC Wealth Management.

“Much of the reporting around fixed income profiles it as a stand-alone source of return. Which it can be. But for most people it plays a role in a portfolio,” he explains. “And when you look at it in those terms you have to think about fixed income in a different way, not just can I still get as robust returns as I used to. That is not the only consideration in a portfolio context.”

It is a case of classic portfolio diversification, says Mr King, harking back to the words his former CIO said to him when he first started in the financial world: “People hold fixed income to enable them to be brave enough to hold equities.”

He believes that although there have been times when correlations between asset classes have spiked over the last decade or so in periods of extreme stress, in the long-term the concepts of portfolio diversification still work, and that investors still want to own fixed income as part of an allocation.

Yields are undoubtedly low, but Håkan Enoksson, RBC’s head of fixed income, believes bonds are still an attractive place to be, and does not see much credibility in the idea of a ‘great rotation’ out of the asset class and into equities. “Why should we see a disorderly sell-off?” he asks. “There is no real interest in this. If we look at why we are in such a low yield environment, the biggest impact is the central banks, with quantitative easing the biggest driver.”

The central banks would not be keen to see a quick sell off because investors holding fixed income would suffer negative returns, which would in turn hit their purchasing power and derail any signs of a recovery.

Turning to corporate bonds, Mr Enoksson believes they have seen extraordinarily high risk premiums, but that these have been distorted, making this an attractive space to be in. “If we look at what these premiums are composed of – traditionally it used to be default rates, and the risk premium was essentially corporate bond over government bond. But default rates haven’t been particularly high. There was an expectation that they would go through the roof, but that never materialised.”

However, for an investor to really benefit from fixed income exposure, he believes that the traditional “laddered” bond exposure – buying a series of overlapping bonds with staggered maturity dates and waiting for them to mature – is no longer suitable.

“Everyone has to be a lot more active in the fixed income space these days; that is the new mentality,” he explains. “What we are doing is spending a lot of time identifying what are the most liquid bonds out there, and making sure that we have a six month view on the bond rather than having a view on the bond for example to 2023.”

RBC has a strict sell and buy policy where they essentially sell off the bond when they have achieved the initial objectives, adds Mr Enoksson.

He highlights the financials space as an area worth considering, while adding that the telecoms sector is one sector that he is currently wary of.

RBC Wealth Management, which has more than C$353bn (€260bn) of assets under management, predominantly looks at investment grade bonds, and has built up its capabilities around what its wealthy client base broadly needs. But those clients who are looking to access emerging market debt or high yield bonds are generally catered for using third party funds. “We are an open architecture shop, so while we certainly use a lot of internal capability in some of our investment solutions, a broad part of our investment solutions is knowing other firms and other funds when we need to use them,” says Mr King.