Bonds and treasuries 'are safe' options
Compared to the ebbs and flows of the equity markets, investing in bonds and treasuries can seem less exciting and perhaps not so rewarding. However, any investment adviser worth his or her weight in commissions will say that bonds and treasuries are an important part of a diversified investment portfolio.
'Fixed-income tools are essential to achieve a balanced portfolio because they are less volatile than many other types of investments,' says Kanas Chan, head of fixed income, Asia-Pacific, at Deutsche Bank, Private Wealth Management. She says investors with a high level of exposure to non-blue chip equities should consider balancing out their risk with bonds and treasuries.
Chan says that in addition to the benefits of portfolio diversification, the attractiveness of a carefully positioned bond allocation is that it can provide a substantially greater yield than cash and, in some instances, investors can expect equity-level returns. 'With market uncertainty expected to stay around for some time, the credit market is also likely to remain volatile, so investors need to seek protection,' she says.
'In the current bond market, interest rates are low and credit spreads are tight and almost comparable to pre-crisis levels, particularly regarding investment grade bonds. With companies, governments, and large corporations taking the opportunity to issues bonds when there is a lot of available funding, in this environment, we have to be cautious in selecting the best bonds.'
Investors should also consider spreading their bond investments over different geographical areas and currencies.
'Quite often, Asian investors have a preference for one currency, such as the US dollar, or confine their investments to a single geographical area. We suggest they look at places such as Russia, Brazil and Mexico, that can offer more yield,' Chan says.
She says swaptions, that offer protection against adverse movements in interest rates, could provide an alternative investment solution for sophisticated investors. Combined with other instruments, swaptions are frequently used to minimise financing or hedging costs.
'Despite an amazing rally in the credit markets since last year, we still feel that there are excellent opportunities in fixed income. Besides issues of portfolio diversification and asset allocation, there are reasons to believe that pockets within the bond universe are still under-valued,' says Ivan Leung, chief investment strategist at JP Morgan Private Bank in Asia. On the downside, Leung says treasury yields are low. 'While the United States is currently experiencing deflationary headwinds, one would expect that, as the world recovers, inflationary pressures will eventually pick up as commodity prices rise, emerging markets continue to invest and consume, and jobs are gradually created in the developed world.
'On the upside, we see selective credit opportunities such as high yield corporate bonds and leveraged loans. As credit spreads are still attractive and corporate fundamentals are improving, it would not be surprising if both were up in 2010 as much as US equities. Local currency emerging market bonds are also investments that we like. Here we anticipate similar 'teen' return potential, but driven from higher yields and from currency appreciation against the US dollar.'
According to Chew Soon Gek, Clariden Leu's head of portfolio management and investment strategy, Asia, emerging market bonds remain the sector of choice as economic and credit fundamentals remain strong. 'We see funds flowing into this asset class which supports the positive momentum,' Chew says.
She says in addition to stronger economic prospects relative to advanced economies, developing economies have solid fiscal positions.
The International Monetary Fund (IMF) forecasts mature economies to grow by 2.25 per cent this year and 2.5 per cent next year, while emerging and developing economies, led by Asia, should see their growth accelerate to 6.25 per cent this year.
'Fiscal positions of emerging economies start from a position of much lower outstanding public debt. Some lessons were learned from the Asian and Russian crises of 1997 and 1998. For instance, domestic capital markets were developed to reduce dependency on foreign capital markets and pension systems were strengthened,' Chew says. 'We favour high-yield bonds due to improving fundamentals from both a macro and corporate perspective. We expect further spread tightening as corporate default rates fall and refinancing continues as investors seek high yields.'
Convertible bonds are also attractive as the bond floor improves from lower credit spreads and the bonds upside is tied to its gearing to equity markets.
Chew also expects equity markets to do well this year, bettering corporate bond returns.
'In our client portfolios, we recommend holding a diversified basket of bonds, equities, cash, commodities and alternative investments. The proportion of fixed income holdings relative to other risky assets is a function of the return objective and risk appetite of the client,' Chew says.
She says the greater the requirement for capital preservation and steady income return, the higher the weight for bonds.
For a conservative client with a below average risk tolerance and an investment period of five years, Chew recommends holding 58 per cent in fixed income, 22 per cent in equities, 12 per cent in alternatives, 2 per cent in gold and 6 per cent in cash. For moderate risk investors, with an investment horizon of at least six years, Chew's asset allocation recommendation is 35 per cent in fixed income, 42 per cent in equities, 16 per cent in alternatives, including commodities, 4 per cent in gold and 3 per cent in cash.
'We are underweight in government bonds in the developed world. Of current concern, in bond markets is the shaky state of public finances in the developed world, and the increased supply of investment vehicles,' she says.
The key in determining whether a particular bond has the potential for price appreciation depends on whether an issuer's rating could be upgraded, interest rates fall or if a currency appreciates.
