The current bond market landscape is interesting, with signs that bond yields have peaked, in the short term at least.
This may present a potential turning point for fixed income and ‘bond-adjacent’ assets, such as infrastructure, that have been under pressure due to rising longer-term rates.
However, with inflation persisting and growth remaining hard to deliver, yields may remain higher than many economies can afford, leading to scope for greater currency movements to come into play than investors may be prepared for.
In the early 2000s an emerging market debt crisis led to sharp falls in various currencies.
This time around it may be some developed market currencies that find themselves in the crosshairs, as they discover that underlying growth and debt dynamics apply to all debtors and that a developed market moniker doesn’t save you if your dynamics are poor.
The US seems to have appreciated this and is at the beginning of an extended period of cost cutting, reduction of both the state and bureaucracy, and of wider liabilities, such as the recent passing the parcel of European defence cost back to European states.
However, these actions in turn imperil growth elsewhere, simply making books more difficult to balance.
The shifting rate and global growth environment could lead to significant reallocations of capital.
Some European sovereigns have a fine line to tread, with poor debt and growth dynamics and new defence liabilities, and competent, pre-emptive government will be key – though that seems to be in short supply at times.
EM bonds may begin to offer better risk/reward characteristics.
For example, we see India and Brazil now providing attractive relative bond and currency metrics.
India has some of the best long-term metrics, while Brazil, with a more favourable debt-to-GDP ratio and growth potential than some developed markets, and having already had a pressure release in terms of a recent currency adjustment, looks an attractive play.
Among developed market bonds we have limited European and reduced UK exposure, while Norway and Japan look comparatively attractive.
Rising longer-term cap rates have also been a big headwind for other bond-adjacent assets such as infrastructure and lending funds, and a stabilisation in rates is now beginning to unlock value here, after a very difficult couple of years.
For example, the first takeover of a major infrastructure investment trust, BBGI, was announced last week at a 20 per cent premium to market, highlighting the under-appreciated attractions of a high cap rate, inflation-linked asset in a weakening environment.
The performance of gold and bitcoin also continue to confirm that all is not well in the world of fiat currency and for that reason our defensive strategy also owns a range of gold miners, as well as significant exposure to attractive bonds and deeply discounted infrastructure and quality-with-value equity assets.
In a broader context, investors should reassess their exposure to bonds, equities and currencies within their portfolios, as the shifting rate and global growth environment could lead to significant reallocations of capital.
Jon Gumpel is investment manager and director at Aubrey Capital Management, where he leads the defensive income strategy
