To generate returns in the current low-rate environment fixed-income investors need to look overseas, says Nuria Ribas Lequerica, investment director at Legg Mason Global Asset Management’s U.K. office.
Emerging markets and developed markets in Asia offer the best opportunities, she says, adding improved credit ratings point to strength in these regions.
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Comparing 2001’s ratings to this year’s, Indonesia has jumped from CCC to BB; the Philippines from BB to BBB; Malaysia and Korea from BBB to A; and China from BBB to AA.
“In most cases this is a result of excellent fiscal positions,” Lequerica explains. “Their debt-to-GDP ratios are relatively low.”
Asian bonds have the added benefit of low correlations to other markets, so they can decrease the overall volatility of portfolios. “There will be times when correlations go up to 1 – this May is a perfect example. It was the third-worst month for fixed income in the last 20 years, but we don’t expect this to happen [again] anytime soon,” she says.
Emerging market sovereigns priced in U.S. dollars are currently expensive, but many corporates have a good profile. “On a sector level, we like mining, and oil and gas. To make specific selections, we identify companies that act as the backbones of their country’s economies – we don’t invest in the corner shops,” Lequerica says.
In some cases, these firms are sovereign-linked or owned, “so if they run into trouble government reserves will be injected to support them.”
When it comes to mortgage-based securities, Lequerica doesn’t mince words: “Stay away – they’re much too volatile.”
She also plays carefully with currency. “It’s very volatile on its own, but can be a good hedging tool to reduce overall volatility in the portfolio.”
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In the investment-grade category, she says, opportunities are few.
“One of the things we’re doing is buying U.S. banks and other financial companies in euros. There’s more yield because these companies are not known in Europe, and to make them attractive to European and U.K. investors there’s an incentive with the euro.”
For bond buys, cash rules
Lequerica stresses the three-pronged character of her investment process.
The first two components focus on fundamentals and valuations. In the case of fixed-income investing fundamental analysis will emphasize cash flows.
“I want to see companies with loads of cash on their balance sheets, because as a bond buyer I want the seller to have the ability to pay me back,” she says.
The third component is the unquantifiable way investor emotion and sentiment can move markets.
One example is German equity markets this April. “There was bad data coming out of Germany, but equity markets were rallying. It didn’t seem to make sense,” says Lequerica.
She explains the ECB was set to meet in a week-and-a-half. The market said to itself: poor economic data means the ECB has to cut rates, which should improve conditions. “So the market jumped two steps ahead of the announcement,” she notes.
Lequerica says the best thing to do is prepare by devising contingency plans. “But we don’t try to anticipate the market. Our tactical moves are more medium-term in nature,” she adds.