Dealing in debt: are government bonds still risk free?

Is there such a thing as a risk-free asset in the fixed income world anymore? Citywire Global canvasses leading fund selectors to see how they fared in 2011 and where they are pinning their hopes in 2012.

Juan Manuel Vicente, Casadevall, Kessler & Casadevall Asesoramiento Financiero (Spain)

Fixed income fund investing has not been such a bad investment in 2011. According to the Lipper mutual fund bond indices average performance was around 2.5% in euro terms. Only the debt of a few peripheral eurozone countries has been a bad investment overall this past year.

The market turbulence that developed into a storm last summer has meant that corporate bonds ended the year in negative territory but this was not too dramatic.

This is not to ignore the risks associated with a possible (but unlikely) blow-up of the eurozone and the resurgence of the serious debt issues facing other developed economies like the US and the UK. The way of dealing with this is two-sided. One is through global bond funds with ample diversification and sophistication which implement a varied number of uncorrelated strategies and trades.

The other is expressing cautiously your asset allocation views with pure fund plays that in our case have been leading us for some months already to US Treasuries with currency exposure and, with a longer term view, to Spanish government debt.

Leonardo Bernardini, Altis Investment Management (The Netherlands)

As the concept of the risk-free asset has been losing validity over the past years, we believe it’s important to diversify the core of the portfolio among a range of ‘close-to-risk-free’ assets.

Apart from the few traditional AAA Euro government bonds that are left, one can think of supranational bonds, non-Euro AAA bonds or very high quality asset backed securities.

Managers with expertise in these areas can help to build a well-diversified, high quality portfolio. Next to that, we also aim to increase diversification in the corporate bond universe, by looking at global corporate managers next to Euro specialists. The global corporate bond universe is about four times as large as the Euro one, moreover it is less dominated by the financial sector.

Therefore, a global corporate allocation allows for greater general diversification, more alpha potential and less exposure to eurozone sovereign risks.

Vincent Puche, Insti7 (France)

The government bond market is being reassessed by investors and traders in the eurozone and some are avoiding this market and looking for alternative asset classes such as corporate bonds. We are already implementing this risk-oriented approach with our clients and consider bond allocation by splitting assets into specific fixed income asset classes.

At the beginning of the crisis some of our clients had specialised portfolios with separate investments in government bonds, corporate bonds, financial institutional bonds, or in covered bonds or agencies.

This structure enabled them to manage global risk by allocation. It is no surprise to see among our clients that government bonds retention is at its lowest level since we have advised on them.

We favour a more specialised range of fixed income investments that focus on the underlying asset class to bring diversification and flexibility to the management of global risk.

The current crisis has modified the approach to investing in fixed income brutally and profoundly and risk management is now the main driver of fund selection.

Pedro Díez Sánchez, Youfirst Smart Finance (Spain)

In the financial sector, everything is typically either black or white. The best way to take advantage of the opportunities created by certain over-magnified movements is by investing in grey, which could be a lighter or darker shade depending on the circumstances. Sometimes, you have to choose the strategy that is the opposite to where your emotions would point to.

Following this rationale, the problem is not of the lack of guarantees at the moment but rather the lack of enough guarantees to reassure investors completely, since the market has become more irrational than ever.

If we believe that interest rates will remain low during 2012 and that the systemic risk is going to diminish, we should invest in assets whose credit spreads have been widening the most in recent months such as high yield and emerging bond funds.

These assets promise higher returns when investors revert to more rational behaviour. I prefer funds with medium or long duration and favour the following: Julius Baer Global High Yield Bond, Fidelity European High Yield, Pictet US High Yield, Pioneer Emerging Markets Bond and BNY Mellon Emerging Markets Debt Local Currency.

Ferdinand Verwyen, Norddeutsche Landesbank Luxembourg (Germany)

In the current crisis-management driven environment we take a core satellite type approach. We strive to stabilise the core part of the portfolio diversifying in a mixture of total return funds such as JB Absolute Return Bond fund, PIMCO Unconstrained fund and M&G Optimal Income. These investments embed an actively managed credit exposure.

For the satellite part, we also buy funds which cover specialised themes such as M&G European Inflation Corporate Bond fund which should profit especially from a dual structure of inflation and credit-linked exposure.

To cover volatility and avoid issuer risk we resort to an in-house fund solution of defensive strategies using exchange-listed options.

This article originally appeared as part of the Buyers' Market feature in the February 2012 issue of Citywire Global magazine.