Posted inAnalysisEuropeFixed IncomeFRENELUXSOUTHERN EUROPE

Risky bonds – firmly back in favour

High yield bonds recorded net inflows above €3bn for the third straight month in April, according to Morningstar’s fund flows data. The last time such a buying streak was recorded was in January-March last year. The recovery of emerging market debt is a little less strong, but still noteworthy considering all the talk around a US rate hike and its effects on Asian debt markets. There is a conspicuous gap in flows between local currency and dollar-denominated bonds though, with the former being sold off and the latter showing positive flows.

Investors poured in a net €1.3bn, placing the asset class almost on par with developed market corporate bonds. Inflows into investment grade government bonds tumbled below €0.5bn over the month, the lowest amount since September.

For European government bonds, there is an interesting dispersion in inflows into short- and long-duration. Since the ECB announced its QE programme in January, net inflows into long-duration bonds have shot up (see graph below), while net flows into short-duration have turned negative. This probably helps to explain the near-zero yields reached by core eurozone 10-year bonds in April and the flattening of the yield curve over that period.

 Directional change

But since then, under influence of higher inflation expectations, slightly higher than expected economic growth and increasing Grexit rumours, bond yields have reversed course. And so might have fund flows.

Indeed, following the recent turmoil on the bond markets and the increasing Grexit-risk, many fund selectors have reduced their risk exposure. “We don’t have any exposure to long-duration government bonds anymore,” says Tim Peeters, head of securities portfolios for the Belgian multi-family office Portolani. “Within fixed income, we only use absolute return and short-duration funds.”

Pretty much the same goes for Jaap Bouma, a senior portfolio manager at Optimix in the Netherlands. “We have sold our long exposure to Italian and Spanish government bonds, though we still have short-duration Spanish bonds, and reduced the duration of our bond portfolio from 5.2 to 3,” he says.

To find yield, he is looking at, indeed, high yield bonds and emerging market debt. “We now have a core of safe short-duration government bonds complemented with emerging market debt and US high yield.” Looking at recent fund flows, he might well not be the only fund selector having this view.

Part of the Bonhill Group.