The past few weeks have seen a huge upheaval in the IA Global Bonds industry. Until recently, it was a sort of catch-all entity comprising some 210 strategies investing in a variety of geographies across companies and governments of varying credit quality and applying a plethora of credit options. currency hedging. Given this broad spectrum, advisers could be forgiven for feeling baffled when attempting to navigate the area.
The IA took steps to address this, implementing a comprehensive industry overhaul on April 19, introducing 14 separate categories for government, high-quality, high-yield, and blended bond funds, with sub- categories based on where the bonds are issued. as well as additional categories for inflation linked and specialty bond funds.
A review of the new categories shows why this reclassification was late as they describe a range of strategies that can by no means be considered homogeneous. For example, funds with at least 80% of their assets held in portfolios of inflation-linked bonds from various issuers and currencies are now part of the global inflation-linked bond industry. The USD Corporate Bond and EUR Corporate Bond sectors hold funds that invest at least 80% of their assets in bonds denominated in US dollars and euros respectively, rated BBB less or higher. The Specialist Bond sector, on the other hand, is reserved for funds which invest at least 80% in bonds, but which cannot be included in any of the other IA Bond sectors.
This reclassification, which follows an industry-wide consultation period, will be good news for advisors. The new sectors should make fund selection much easier, as investors can assess funds on a like-for-like basis from a resource, risk and performance perspective. One of the limitations that remain in new sectors is that constituent funds may still contain some degree of hedge spreads, which means investors will need to take this into account in order to avoid misleading comparisons of risk and performance. .
Aside from this reclassification, there has been a lot from a market perspective to keep investors engaged in global bonds. Having been at the lowest since sweeping stimulus packages flooded the market in response to the 2007/08 global financial crisis, government bond yields around the world have soared this year, from UK gilts to US Treasuries in passing through the sovereign debt of Japan, Australia, and across Europe.
This marks a significant reversal of a multi-year trend. In 2016, the yield on a 10-year bond fell below 1% for the first time in the UK, collapsing to 0.5% before gaining ground. At the height of the market sell-off in March last year, government bond yields fell 0.08% in the UK to the 10-year level. Indeed, parts of the yield curve fell into negative territory as the Bank of England looked at negative interest rates. This model has been repeated around the world. However, the first months of 2021 saw a dramatic shift as yield curves around the world begin to move north again, driven by anticipation of an economic recovery and concerns surrounding the return of inflation. .
Despite the low yields on offer in recent years, global bonds have performed well. In 2019, a risky year for broader markets, Global High Yield led the way with a fairly consistent 12% return over the year. Unhedged government bonds from developed markets, the riskiest area in the industry, returned around 2% for the year, with some volatility due to high interest rate risk.
As with all asset classes, 2020 has been significantly more volatile. The high yield index fell by around 25% in March, before recovering over the rest of the year to end around 5%. Government bonds on the other hand, but for a brief liquidity crisis in March, benefited from their risk profile and ended the year up around 7%.
The volatility brought on by the pandemic has created opportunities for active fixed income managers. Of these, the opportunity that stands out is in higher quality credit, as the dramatic surge in spreads in the first quarter of the year left issuers and investors unsure of the financial damage the pandemic would cause to finances. companies, to agree on a very high risk premium for newly issued bonds.
Then, as the scale and pace of government and central bank support became evident, these spreads narrowed over the following quarters, generating strong returns for investors, especially for flexible fund managers. which had moved from higher quality bond and cash markets to investment grade. credit. The first few months of 2021, however, have been more difficult as investors predict that economic growth and the associated inflationary effects are expected to increase the return at which governments can fund themselves.
Against the backdrop of these rapidly changing market dynamics, the AI reclassification of the global bond industry couldn’t come at a better time. There are many opportunities for active fund managers to add value in the global fixed income markets. However, the ability to navigate the wide range of strategies providing exposure to global credit markets with greater clarity is of increased importance if advisers are to select funds that meet their goals with greater certainty.
Chris Fleming is Director of Investment Services at Square Mile Investment Consulting and Research