Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined by Chris Higham, Manager of the Aviva Investors Strategic Bond Fund.
Hi, Chris.
Chris Higham: Good afternoon.
Wall: So, we're here today to talk about bonds, topical as ever because last week the Federal Reserve upped interest rates for the second time in just a few months considering the drought we had before. Now, before Brexit fixed income investors were told as soon as the Fed hikes rates, the U.K. is to follow; however, that's not really the case anymore, is it?
Higham: No, and it's certainly not our expectation. So, we continue to expect interest rates in the U.K. and Europe and for most of the rest of the world to stay very low for still a long period of time. I think obviously in the U.S. that's where the focus is, but our expectations for this year would be for two more hikes, potentially another three to four next year. But we're still looking at, in terms of this whole rate cycle, a terminal interest rate of around 3% in three years' time, which will still be much lower than where we've seen interest rates historically.
And a lot of the drivers for that haven't really changed pre-crisis. So, a lot of the big themes that have been driving our thinking and thoughts for the last, post-crisis, the last 10 years, really the debt backdrop, demographics, inequality, a lot of the big secular drivers that are likely to mean that interest rates will stay low everywhere for still a long period of time.
Wall: And cautious investors though, investors cautious of fixed income, have actually missed out on considerable rallies over the last couple of years, haven't they? I remember at one point gilts were among the best-performing asset classes and people certainly hadn't been in them because they were poised for an interest rate rise in the U.K.?
Higham: Yeah. So, there's certainly been a reassessment of views from the U.K. clients, I would say, post the Brexit vote. So, clearly, in any historical context if you look back at 300 years then 50 basis points interest rates are very, very low, but you need to put that in the context of global interest rates, which whether it's Japan or Europe, are actually negative.
So, I think, there was a reassessment of that in terms of investor views on fixed income post the Brexit vote. But I think the outlook for fixed income in terms of all returns really is still likely to be positive and low in terms of driven really by the policy support that we're seeing globally still.
Wall: And as a strategic bond manager you have a few levers to pull in your portfolio and you have a slightly broader remit than perhaps other more vanilla bond managers. Where are you seeing those opportunities at the moment for growth for investors?
Higham: Yeah, I think, that's absolutely key, because I do think the best scenario really for policymakers given the debt backdrop is, we're likely to see higher levels of inflation in the U.K. given FX and energy but also globally. So, another one of our key themes really is this more sustained level of inflation globally.
So, we remain cautious on government bonds as a consequence. So, we have reduced interest rate risk within the portfolio. So, even though we don't think interest rates will rise, we still think the level of valuation in those assets means that they are pretty expensive assets to own on a long-term view.
For some of the opportunities because of that growth backdrop, so high-yield bonds do perform much more closely correlated with equities. They do perform much better in a growth environment. So, we do think high-yield investment-grade bonds, so credit-type products look set to be the place to perform best in this environment. And in a historical valuation context, we wouldn't say they were absolutely cheap, but we'd say that there's still some value there which is great within fixed income given the amount of policy support that we've seen in certain areas.
Wall: Chris, thank you very much.
Higham: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
