(January 3, 2012) — Blind faith in politicians’ assurances meant investors willing to take a punt on risky bonds were amply rewarded last year, but a leading European fund manager has warned this is unlikely to continue.
The highest-yielding fixed income index last year was that tracking Euro subordinated financial debt, according to M&G Investments’ specialist bloggers: the Bond Vigilantes. The group said this index produced just under a 30% return for investors with a firm constitution who were prepared to hold these securities.
The Bond Vigilantes said: “It seems to us that the ostrich effect (the avoidance of apparently risky financial situations by pretending they do not exist) had a significant impact on markets in 2012.”
The group said the Eurozone bond market had been buoyed by central bank President Mario Draghi’s statement that the institution was prepared to do “whatever it takes” to avoid the collapse of the region’s financial system.
Other well performing indexes included euro high yield – just over 26% – and sterling banking index and just under 24%. The latter’s participants were inextricably linked with the Eurozone predicament and more general financial crisis.
Global emerging market sovereigns yielded almost 21% over the year, only just outperforming an aggregate of Spanish, Portuguese and Greek bonds, which yielded just under 20%.
M&G’s Bond Vigilantes said the themes witnessed in 2012 would continue this year: “In a world of ultra-low interest rates and negative real returns in cash, investors must take on risk. It is precisely what central banks are encouraging us to do. But uncertainty breeds volatility and in order to generate higher returns investors must face this volatility head on. It will be a feature of the market in 2013.”
Nevertheless, the risk taken to achieve these returns might well have been worth it. In December, investment consultants at UK-based firm Redington showed that high yield fixed income, issued in the US and Europe, had a better Sharpe Ratio – the risk/return payoff – than most mainstream asset classes over the 12 months to the end of September. Redington found US high yield had a slightly better risk/return profile than its European counterpart, but both asset classes outperformed equities, commodities and a range of others over a three- and five-year period also. Only emerging market currencies and risk parity performed better over one year, with government bonds making better returns over three- and five-year time periods.
However, the Bond Vigilantes warned that the stellar returns seen in 2012 were unlikely to occur again this year.
They said: “About the only thing we can say for certain is that it is unlikely that fixed income will continue to generate excellent returns across the spectrum from government bonds to high yield. For example, double-digit returns in European investment grade are not normal and have occurred only three times in the last seventeen years. On the other hand, the asset class has posted a negative return in only two of those seventeen years, with the largest loss being -3.3% in 2008.”
To read the full Bond Vigilantes piece, click here.