Global bonds offer most attractive diversification in a decade

For the first time in over a decade, global bonds are finally an appealing option for South African investors, providing steady income and diversification, and protecting portfolio downside. In M&G Investments’ view, global fixed income instruments of various kinds – sovereign bonds, corporate bonds, inflation-linked bonds, emerging market bonds and developed market bonds – are offering attractive real yields that will compensate investors well for the risk of owning them over time. However, this comes with a caveat: given the large differences in investability across different countries, sectors and issuers, and the still-high level of uncertainty prevailing in the global macroeconomic environment when it comes to inflation, interest rates and growth, investors should be selective and somewhat defensive in their exposure, we believe.

Following more than a year-long interest rate hiking cycle by the US Federal Reserve (and other central banks), nominal US Treasury bonds are finally offering meaningful real returns across the yield curve, with the 30-year UST real yield at approximately 1.6% -- a level last seen back in 2013. These longer-dated bonds are one of the preferred holdings in the M&G Global Bond Fund currently.  

Nominal European government bonds, on the other hand, are less desirable for now given that the European Central Bank (ECB) has lagged its counterparts in raising interest rates, and inflation remains relatively high. This increases the odds of interest rates staying higher for longer in the region, adding extra risk versus the US. Even certain emerging markets (EMs) which started lifting interest rates early in the current cycle can provide a better potential return for the risk involved, in our assessment. 

Developed government inflation-linked bonds (ILBs) are also a sound option for investor portfolios currently -- longer-dated US Treasury Inflation-Protected Securities (TIPS) particularly go some way to protect against inflation, as do UK and German ILBs. Emerging market ILBs are generally less attractive in our view, however, as they offer no real yield spread benefits, and a lower real return potential than EM nominal bonds.

Meanwhile, investment-grade (IG) corporate credit yields are also at 10-year highs in both the US and UK markets (with five-year bonds at around 5.8% and 5.6%, respectively). Yet in our view, corporate balance sheets are generally healthy and default risk is lower than what the market is pricing in. We think that at current yields investors are being overcompensated for any reasonable expectation of default, plus IG corporate bonds offer extra portfolio diversification across different sectors and levels of credit rating. In fact, in our view “BBB”- rated corporates are offering the most attractive yields for the risk involved, but investors must do careful analysis because spreads in this one credit rating category range anywhere from 75bps to 700bps. This huge dispersion represents a significant opportunity for investors who do their homework. High-yield bonds, on the other hand, are best avoided at present.   

Looking ahead, defensive positioning is warranted, in our view, and this is reflected in the M&G Global Bond Fund. The impact of global central banks’ aggressive rate hikes has only recently begun to be felt fully as growth slows and inflation falls, and data show that reactions vary across countries. Negative surprises are a real possibility. However, this also presents an unusually large variety of investor opportunities, which, with fixed-income instruments, can mean enhancing both return potential and downside protection in a portfolio.