Investors should prepare for another eventful year in fixed income, according to Fidelity's Andrew Wells.
While Wells concedes that bond yields are comparatively low when investors consider both historical yields and the dividend payments offered by equities, he says that this is simply a natiral reflection of the challenging economic environment.
“Fears of a great rotation by investors out of bonds and into equities are exaggerated,” he says. “While government yields are around historic lows, credit spreads in investment grade and high yield bonds remain well above previous levels.”
In particular, European high yield bonds offer investors ample growth opportunities. While the market remains cautious of the Eurozone much as been done to clean up corporate balance sheets and defaults remain low.
Investment grade bonds offer fewer opportunities however, and investors should be aware they are entering near the top of a long bull market.
“Investors must tread a fine line of pursuing carry, while being nimble enough to reduce risk if market stresses appears,” said Wells. The US is at the front of the releveraging cycle so investors are likely to rotate towards euro credit as well as diversified global credit solutions in order to mitigate some of these risks.”
Liquidity in the coming 12 months will be greatly affected by the Fed’s decision to wind down quantitative easing – and the Bank of Japan’s decision to ramp it up.
Europe is also slowly deleveraging, cutting interest rates.
Franklin Templeton fixed income portfolio manager Michael Hasenstab says that the fear of liquidity being pulled out of emerging markets due to the Fed eventually ending its bond-purchasing program is overstated.
“When the Fed does end its bond purchases, we believe the interest-rate differential will likely be in favour of emerging markets with high growth and inflation dynamics that should dictate higher interest rates than those in the United States,” he said. “We believe the relative value potential of these countries’ assets is still intact as they have not been printing money; therefore the pace of Fed tapering is unlikely to have a fundamental impact on countries that continue to exhibit strong fundamentals.”
Jim Leaviss, bond manager at M&G said that the fundamental outlook for corporate bonds remains positive – thanks to low default levels and minimal risk of inflation in the developed world. But he did warn that investors should not base their expectations on recent years’ performance.
“After returning 5.2%, 10.8% and 0.3% in 2011, 2012 and 2013, investors must recalibrate their expectations for investment grade corporate bonds,” he said. “The impending withdrawal of central bank support could create volatility in risk markets. In this sense, the tapering debate of 2013 gives us a guide to what to expect in 2014.
"However, with spreads starting the New Year both tighter than in 2013 and close to historical averages, excess returns are likely to be lower. We believe most parts of the credit market will struggle to deliver much more than their coupon, but credit remains in favour versus other, even lower yielding, fixed income assets.”
Given the macro challenges facing the bond market in 2014, investors should opt for a fund that allows the manager a broad universe from which to pick their portfolio.
Strategic bond funds invest in all types of fixed income – from cash and gilts to high yield, adapting exposure to suit the market.
Highly rated funds include Henderson Preference & Bond (Morningstar 
Silver Rated) and L&G Dynamic Bond (Silver Rated).
Global bond funds offer investors a chance to pick up emerging market exposure – a sector which fared poorly in 2013, but is expected to pick in in 2014. Highly rated global bond funds include Pimco Global Bond (Silver Rated) and Templeton Global Bond (Silver Rated).
