Emma Wall: Hello and welcome to the Morningstar series, Why Should I Invest With You? I'm Emma Wall and here with me today is Luke Hickmore, Manager of the Aberdeen Strategic Bond Fund.
Hello, Luke.
Luke Hickmore: Good morning.
Wall: So there has been some movement in the bond market this week. Ten year Gilt yields rose to a five-week high of 1.71%, German bunds came up, the two-year gilt yield also came up. Is this a beginning of the end that we all have been waiting for? Is it just going to be yields up and prices down?
Hickmore: I'd love to say yes, but no. I feel we are in a low environment for yields for long time yet, inflation is low, it's going to stay low for at least another two, three months. You've got money being pumped into the bond market by the QE from the ECB every single month and that goes on right through next year.
I'm afraid our view is we stay with these low yields for at least the rest of this year. Now, there will be volatility around that and we've got a few events coming up in the U.K. for example in the next couple of weeks, we will see some volatility. But it's a tough place to find returns in government bonds. I guess for us in the Aberdeen Strategic Bond Fund, we've got a wide investment field we can look at. These aren't fortunately the only things we have to do.
Wall: You mentioned there that we're going to remain in a low yield environment, I suppose that takes the pressure off how you manage money in environment where prices are falling, but low yields still mean low returns and you're looking at the total return. So where can you find value for the investor then?
Hickmore: I think that's a really good point. Everybody has been playing the carry trade for the last five, six, seven years. It's all been about trying to increase the amount of yield you can get from your investments.
And in particular, this is what the ECB wants us to do, they want us to chase into higher and higher risk investments to try and get that carry. And you're right, it's going to dissipate at some point, so you have to think further and further afield.
Now I was looking this morning, you can buy Italian bonds versus German bonds today for a roundabout 1.3% extra. If you look at every single BBB bond in euros, there are five of them that give you more than that and then more risky than the Italian sovereign.
So there are still things we can do, we think that spread can compress a lot. We think Asian investment grade is really interesting at the moment. We've been investing more in the U.K. where the yields are better than they are in Europe and we've been occasionally looking over in the U.S. as well.
Ideally you want some events to happen, so things could get cheaper. Last year's fall in the oil price was a great opportunity to pick up some really good quality businesses at depressed levels. When you can find those things, that's a godsend for a strategic bond fund manager.
Ideally we do see some more volatility as we go through the summer and that's gives us more of a chance to look for things. But on a consistent ongoing basis, it's about getting the mix right between your investment grade and your high-yield bonds. And possibly a little bit more towards high-yields, just at the moment, just to play that carry trade for the last few months, I think that's possibly where you get a little bit of return left.
Wall: And you mentioned there risk and in particular, in sovereign bonds. At what point do you say actually this is too risky for the return being offered, because last year you could actually get more return on an Apple bond than you could on an Italian bond, when Italy look like quite a difficult place to be and Apple is one of the most cash-rich companies in the world.
Hickmore: I've got a very different view of Apple, but that's personal problem I have with the company. Absolutely, and I think it's an important one – how far can this yield drop go? In Germany in particular, this could be 0.2% negative 10-year yields, that's really where the floor becomes important.
And I think that could be the case, autumn this year maybe, at that point, I'd start to get really worried about being invested in government bonds.
When you've got a negative return right the way through the curve, it's really difficult to make any money out of that. And actually even then going into credit that spreads over those government bonds are already negative, difficult again. There are 80%, I think of investment grade bonds in Europe, which yield less than 1%. This is not a great landscape to make a lot of money in, so you look further and further afield.
The risks are rising, you have to be very aware of that. But it's going to take quite a lot for those yields to change dramatically. Nobody sees, we certainly don't expect a big pickup in growth in Europe. Certainly, don't expect a big pickup in inflation. We get this oil price dropouts in the next couple of months, but there's a lot of spare capacity around in the world. You can't look at a single country anymore and think about spare capacity.
You got to think about emerging markets and developed markets and there's a lots of spare capacity around. I think those disinflationary forces could be with us for a while. So you're nervous about levels, but you kind of need to be in it.
Wall: I can't let you go without picking up on that Apple comment, I'm afraid, so why are you not happy with Apple?
Hickmore: I've always been an Android man, not an Apple man, but there we are, that's just me. From a company perspective, they're perfectly good, sound quality credit, but I don't like their products.
Wall: Luke, thank you very much.
Hickmore: Thank you very much.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
