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Bonds more attractive than cash over the medium term
Yields continue to rise, but uncertainties may adversely affect asset class
Bayani S. Cruz 15 Nov 2023

Bonds, particularly global bonds, look more attractive than cash from a valuation perspective and offer good prospective returns over the medium term, especially if there is further economic slowdown.

This is the consensus among fixed income experts, who also advise bond investors to be mindful of uncertainties that may adversely impact the asset class until the end of the year.

“From a valuation perspective, the current level of yields looks relatively attractive by historical standards, but it's a little bit simplistic to just look at the level of yields. In the very near term, between now and the end of the year, there are a lot of uncertainties, and it's perhaps nuanced across regions as well. It's probably a good time to start lengthening duration, but probably not the right time to go all in,” says Paul Saint Pasteur, director and global fixed income portfolio manager at Payden & Rygel, an asset management firm with over US$144 billion in assets under management.

Although inflation has eased, it has remained at high levels, prompting central banks to maintain a tightened monetary policy longer than expected.

Meanwhile, economic growth, particularly in the United States, is better than expected and continues to push yields higher. Also, the growing supply of US treasury bonds, in particular, have led to supply-and-demand imbalances in the bond market.

“All three factors have contributed to yields moving higher to levels that we haven't seen since the Great Financial Crisis. To give you an example, the euro hedged yield on the global aggregate bond index is just under 4.0% right now,” Pasteur explains.

For his part, Duncan Lamont, head of strategic research at Schroders, believes that bonds now offer long-term investors an appealing combination of higher return potential and lower downside risk.

“Thanks to rising bond yields, you can now get a yield of 6.3% on US investment-grade corporate bonds. High-yield debt is riskier but offers 9.4%. Dollar-denominated emerging market debt, which straddles investment-grade and high-yield credit ratings, also offers 9.4%. Even US government bonds now yield 5%. These are the highest yields seen in the last two decades,” Lamont says.

With these higher yields, bonds have a higher return outlook than cash. “In addition, bonds also offer a historically high margin of safety against losses. Bond prices move inversely with yields so a rise in yield leads to a fall in price. The margin of safety is how much a rise in yields they can absorb over the next 12 months before investors would lose money,” he says.

“Investment-grade bond yields would have to rise further by 1.0% to wipe out the current yield and US treasury yields almost as much. High-yield bonds can absorb a 2.4% rise and emerging market debt, 1.5%. These two asset classes offer similar yields but their prices have different sensitivities in yields, which is why their margins of safety differ,” Lamont adds.

On a macro level, Pasteur argues that although global economic growth is currently stronger than expected, it is likely to slow down going forward in the face of monetary tightening by central banks.

“There's still a lot of uncertainty in the economy and markets, but I think the combination of attractive all-in yields and the risk of seeing some form of global economic slowdown next year should be good for global fixed income,” he says.

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