Henderson: Fixed Income View: a focus on defensive income streams

In recent weeks markets have challenged the extent to which central banks can continue with their current rate of unprecedented monetary stimulus. Modifications have subsequently been made by the Bank of Japan, and the European Central Bank (ECB) will also need to review its approach. This has not deterred the hunt for yield, which remains the dominant feature in fixed income markets.

Opportunities in global markets

As 2016 has progressed we have increasingly tilted our multi-sector portfolios towards US dollar-denominated assets, particularly in emerging market credit and towards US inflation-linked bonds. That said, there remain some excellent opportunities in European credit markets for global investors, which sometimes go unnoticed due to the lower headline yields available. Given negative cash rates in the eurozone, investors who operate in US (or Australian) dollar terms can earn a significant pick up in expected return when buying euro-denominated assets and hedging this exposure back to their home currency.

European bank loans

While we are generally avoiding low yielding investment grade bonds in euros, at the current point in the cycle we continue to see European bank loans as one of the more attractive asset classes available on a risk-adjusted return basis. From a fundamental perspective, European companies are operating more conservatively than their US peers, and European banks are still loosening credit standards. In contrast, the US is exhibiting more late cycle behaviour, which is typically less friendly for bondholders, such as borrowing to finance aggressive acquisitions or to pay dividends to shareholders.

Comparing high yield bonds and senior secured loans, the all-in-yields on secured loans are in many cases at similar or higher levels in Europe than on the equivalent high yield bonds. Effectively, this provides the benefit of seniority and security in the capital structure for a loan investor, without sacrificing expected return. Moreover, given how far government bond yields have fallen, we see limited potential for further duration-led capital appreciation in the bond market versus the loan market. For example, Douglas a perfume and cosmetics company based in Germany, currently has a secured loan yielding around 4.4% pa, which is more than 1% pa above the yield on their senior secured (pari passu) high yield bond (as at end September 2016).

The appeal of secured loans

While secured loans have lagged other parts of the credit markets, such as US high yield, so far in 2016, the resilience of the asset class across a range of scenarios is an attractive feature. As a reminder, the chart below shows the resilience an allocation to European secured loans can provide, when assessed through two recent government bond sell-offs. With recent headlines about the possibility of the ECB slowing its quantitative easing programme at some point in the future and recent comments by UK Prime Minister Theresa May, suggesting more of a role for fiscal policy, thoughts of increased volatility in government bond markets have crept back onto the agenda.