Despite the efforts of the ECB, Europe as a region remains in a low growth, low inflation and low yield environment. Is the continent going the same way as Japan which has suffered similar problems over the years?
Asset manager Canada Life suggested it was a real possibility at a discussion held at their offices recently.
David Arnaud, senior fund manager in the fixed income team said Japanese government bonds have been suppressed for 10 years so there’s no investment case there. He added that growth has been stuck between zero and one percent with debt to GDP extremely high at over 200 percent.
“We are heading to this environment in Europe, started in 1999 when Japanese sovereign bonds were yielding 2 percent now they are at stuck zero for the last 5 years. In Europe 10 year bunds are already at zero. The big fall in yield has already happened,” said Mr Arnaud.
One of results of Japanification of Europe is less differentiation between core Eurozone and peripheral Eurozone as spreads compress. Another is that it is going to push investors towards corporate bonds which can add risk to portfolios.
Investors may also want to look at subordinated bank debt and high yield given the low yield, low growth environment in Europe.
The potential for triple B bonds to be downgraded is also a concern for the firm as it means that those bonds will no longer be investment grade and therefore potentially not be able to be held by certain institutional investors.
Mr Arnaud said that the large US company GE is an example of what can happen to triple B bonds. This company saw its ratings fall from top end investment grade down to triple B. However, with billions of dollars of paper outstanding the fall in credit quality seems to have been stopped for now with ‘its story improving’.
Kshitij Sinha, fund manager in fixed income at the firm, made the point that triple B risk is what makes active management attractive. Those investors buying an index of bonds are not looking at the credit fundamentals of the company and given market cap weightings are just buying the most indebted companies. A strategy that could be perilous in changing rating scenarios.
Canada Life offers a range of fixed income products although both Mr Arnaud and Mr Sinha both manage the Global Macro Bond Fund, which is structured as an OEIC. This fund invests solely in developed market currencies, investment grade and sovereign bonds without using any derivatives in an attempt to ‘juice-up’ returns. It is a long only fund with £179.8 million in assets and a fairly short average duration of 5.2 years.
