Arthur Wu, senior investment analyst, discusses fixed income investments at the Investment Solutions Forum 2016 in Singapore on 2 June. During his session, he suggested that the validity of government bonds as a diversifier is questionable given their low yields. Over the past 5 years, yields fell from around 2.5% to around 0.7% while duration increased from around six years to eight years. On the other hand, asset classes like Asian bonds are gaining prominence in portfolios across institutions.
Q: How important this year are fixed income investments or alternatives like credit notes – which gives you a steady stream of income?
Wu: Fixed income is still very important for the simple reason that there are not many diversifiers available to cushion volatility in equities. Sure, you can use “safe-haven assets” like gold, but you will be exposed to other risks instead. Something to highlight, however, is the evolution of the fixed income asset class, in particular, the classic diversifier: government bonds. At this current juncture, the validity of government bonds as a diversifier is questionable given their low yields. Case in point, over the past 5 years, yields fell from around 2.5% to around 0.7% while duration increased from around 6 years to 8 years. On the topic of yielding products, asset classes like Asian bonds gaining prominence in portfolios across institutions. This is still very relevant for portfolios seeking yields as safer ends of the spectrum offer little to no yields. On our end, our manager research team is increasing coverage on this asset class.
Q: How can investors be creative in generating yield – especially in Asian local currency where rates are a little higher?
Wu: The innovation follows an evolutionary pattern. First, the search for yields begun after ZIRP. Back then it was simple. Investors just flocked into yield enhancing bonds at decent yield levels (U.S. HY has yields about 8-9%). Through the passage of time, there were numerous innovations. At the fundamental level, basically, there are 6 main permutations (3 external, 3 internal) investors can increase their yields. Externally, yields can be enhanced by (i) Hedging them against higher carry currencies like AUD, (ii) higher allocation in Asian/EMD, (iii) financial derivative innovation such (i.e. call overriding). Internally yields can be enhanced by (i) having a longer duration), (ii) moving down the credit quality spectrum and (iii) picking specific sectors that have been beaten down (i.e. oil). Ultimately, the play on yields is dependent on the price of bonds. One on end, when yields are decent, investors will just flock to simple products. When bonds are expensive, it is just a conflux of the 6 factors at play, until yield levels are attractive again.
