US rates to reach 6 per cent, says ING specialist
Investors should tread carefully when considering corporate bonds, Chris Davis reports
Last week's US interest rate increase to 5.25 per cent came as no surprise to Robert Kinsey, ING Investment Management senior portfolio specialist for fixed income, who expects the Federal Reserve to raise rates to 6 per cent in the coming months.
'From the beginning of the year we have been out on a limb, saying that interest rates will continue rising until they reach the 6 per cent mark,' Mr Kinsey said.
Anticipation of Thursday's decision has been driving down bond prices for weeks. The yield on the US 10-year note remains slightly below the yield of the two-year note.
However, as a bond specialist Mr Kinsey is quick to point out that picking successful bond investments is not just reliant on fluctuating interest rates. With US$165 billion under management, Mr Kinsey and his team look for bonds to invest in offered by companies that are possible candidates for acquisition or show characteristics similar to other companies that have been acquired.
The overall strategy is to maintain exposure less than the index. Specifically, the ING investment team avoids companies with depressed stock prices and under-utilised assets on the books.
'Opportunities for positive returns always exist for investors who focus on well-researched selection and value discovery,' Mr Kinsey said. While calculated risk forms an integral part of investing, there is never a sound reason to stretch for yield and take on risk without adequate compensation.
Along with several other bond specialists, Mr Kinsey views corporate bonds as an area where investors should tread carefully. They see event risk increasing as companies merge and undertake leveraged buyouts. These manoeuvres, as well as the use of cash to repurchase stock and boost dividends, tend to favour stockholders over creditors.
'Investors need to be more attuned to surprises to protect their positions,' Mr Kinsey said.
Investors and bond managers also need to be careful about what they buy and in some cases it is what they don't own that can make a difference between generating maximum returns. He cautions that in this environment, Asian investors should be wary of the US bond market. 'I would have to say that US bonds should be treated cautiously by Asian investors looking for alpha [returns], which could pale as a result of currency or interest-rate corrections,' Mr Kinsey said.
Looking ahead, Asian investors without a US dollar fixed-income mandate should begin ground work now in readiness to enter the US dollar market when interest rates peak. Reluctant to speculate when this may happen, Mr Kinsey said even Wall Street economists would struggle to predict the timing and magnitude of the end of the current cycle of interest rate rises.
In addition, the US trade deficit along with the consumer propensity to borrow are poor habits that do not look good for the long-term health of the dollar.
Mr Kinsey said the present situation threatens to complicate the job of Federal Reserve chairman Ben Bernanke of keeping the economy growing while keeping inflation under control. The combination of strong growth in the US and easy monetary policy abroad partly explains why bond yields have remained low even in the face of enormous US financing needs.
Mr Kinsey believes that Mr Bernanke's policy of transparency and liking for data-dependent information to indicate where the US economy is going have been unfairly lambasted by Wall Street and TV pundits. 'Even with former chairman [Alan] Greenspan at the helm, things would probably be very similar. We are hovering around an inflection point with numbers pointing in different ways so markets would still be vacillating even with Mr Greenspan in charge,' said Mr Kinsey.
Some of the more challenging environments for an active fixed-income manager are periods of low volatility, tight credit spreads and low overall yields. 'The temptation to reach for yield is acute, but the danger in doing so increases incrementally as the alpha drought continues,' said Mr Kinsey.
Low returns over the past few years have led many market participants to adopt risky measures in search of yield.
'The immediate gratification of higher yields sooths many who ignore the fact that yield is only one element of total return which should be looked at in conjunction with changes in price,' Mr Kinsey said.