Sander Bus and Victor Verberk, Robeco’s co-heads of credit, are “growing increasingly uncomfortable” about return prospects for the asset class after the strong performance of credit markets year-to-date, they wrote in a note.
“Every blip wider in credit is being absorbed by demand. At the same time, investors have burnt their fingers so often with bearish positions that they have simply given up betting on down markets. That means that potential risks are hardly priced in,” they wrote.
Take no risk
Over the past few years, credit has benefited from the double tailwinds of easy central bank policy and tightening spreads. However, this blessing risks turning into a curse since central banks are starting to withdraw stimulus at a moment credit spreads are at all-time lows.
Verberk and Bus have drawn their conclusion: “This is no longer the time to stick your neck out and take risk. With central banks backtracking, investors are less likely to buy on dips.”
Chris Iggo, fixed income CIO at Axa Investment Managers, is also facing up to the grim reality that credit outperformance is likely to soon be a thing of the past.
"This is no longer the time to stick your neck out and take risk" - Robeco
“Valuations are extreme,” he says, taking the opportunity to remind investors it is still not a good idea to fight central banks, even as the effects of their policies will be the opposite of what they were since 2009: exerting downward rather than upward pressure on bond prices going forward.
“It means not trying to extract the last bit of credit compression in European corporate and peripheral markets and it means no longer relying on the central bank 'put' to hedge against a rise in default rates in high yield.
“In the US market, yields have been rising since mid-2016 but if the Fed is to be believed, yields will keep on moving higher,” says Iggo.
Iggo also manages a flexible bond fund which has benefited from the credit tailwinds more or less ever since it was launched in 2012.
“Being overweight credit relative to rates with a preference for high yield and emerging markets has turned out to be a winning strategy,” he says. “Going forward, however, it might be a different story. We are at the end of the period of central bank dominance.”
In fact, most flexible bond funds have taken such an approach in recent years, enabling them to deliver solid returns to investors and gather ever more assets.
Moreover, such unconstrained bond funds have been by far the best-selling fund category in 2017 with European fund buyers, topping the sales charts in seven of the first eight months of the year, according to Morningstar data.
High-yield bonds are unlikely to remain the one-way bet they have been for the past 20 months or so (see graph), according to Verberk and Bus. Moreover, the “abundant liquidity” that has driven high-yield returns could turn against the asset class.
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