It has been a tough start to 2018 for bond investors, with government and corporate bonds across the globe delivering capital losses, according to Matthew Toms, investment associate at Heartwood Investment Management.
The latest insights from Heartwood indicates that the US has led the way, with the short-medium section of the US yield curving the most.
Fears of rising inflation and the prospect of interest rate increases beyond those previously forecast seem to be the main drivers.
According to Toms, this yield curve move has infected corporate bonds and emerging bonds, culminating in negative returns for both asset classes.
Meanwhile, credit spreads have barely moved this year, indicating investors remain optimistic about default risk.
For three reasons, Toms attests that Heartwood will not be inclined to increase bond exposure in order to take advantage of higher yields.
Firstly, inflation is expected to pick up, potentially pushing yields higher still and delivering further capital losses.
Additionally, valuations still look unattractive in most areas of fixed income, according to Toms.
Finally, whilst US treasury, corporate and EM dollar-denominated bonds are yielding more than they were at the start of the year, the cost of hedging US dollar/sterling has rocketed this year, thereby reducing potential returns to sterling investors, Toms says.
Toms continued: “We normally look to hedge our overseas bond holdings because otherwise currency movements tend to swamp the underlying bond return.”
Pleasingly, however, Toms says there is a tiny splash of green in an otherwise sea of red, as European ABS positions have small positive returns so far in 2018.
