ETF Report UK: The Outlook For Fixed Income in 2015

December 24, 2014

[To read the full PDF version of our latest quarterly magazine, ETF Report UK, click here]

As the US Federal Reserve wraps up almost six years of quantitative easing and turns its focus to raising short-term borrowing rates, concerns are mounting as to just what investors should do about their fixed income exposure.

These are uncharted waters, so you might as well throw out the rule books on fixed income investing, according to Rick Rieder, BlackRock's chief investment officer of Fundamental Fixed Income, and co-head of Americas Fixed Income. He says that bond investors must be tactical and opportunistic in a way they never had to be before.

Rieder shared his views on what an aging population and a deleveraging world mean for investors and how they should manage their fixed income.

ETF Report UK: Bank of America recently estimated that nearly half of the world's supply of government bonds is yielding less than 1 percent thanks to all this quantitative easing we're seeing worldwide. What does that mean to fixed income investors?

Rieder: It's tremendously important. We live in a world where there are two events happening simultaneously that are creating what's going to be a low interest rate environment for a long time: 1) you have a population that's aging and that has a demand for fixed income assets; 2) you have a delevering of the world, and that means you're not producing a significant amount of fixed income—in fact, you're producing a fraction of the fixed income assets that came a decade ago.

Much of the reason we're going to continue to be in this cycle is that you have monetary policy that's trying to create growth and normalised inflationary conditions, and that's buying assets or keeping real rates extremely low at the same point in time that the population is aging, and has this tremendous demand for income.

For the next few years, what investors have to think about is how different this environment is going to be versus history; how you have to be flexible and opportunistic and find areas to generate return. For 25 years we've lived in a declining interest rate environment. This decline came at the same time the system was producing more and more fixed income, because the world was levering.

Now you have to think about fixed income literally almost the exact opposite as you did a decade ago or 20 years ago. You have to be opportunistic, and you have to be thoughtful about investing globally, being tactical where there's opportunities because you can't just sit back and hope that your income, your coupon flow is going to work for you.

ETF Report UK: How do you adjust this scenario if all of a sudden we manage to get growth in the US to pick up, or on the other side, if the eurozone completely collapses?

Rieder: You have to be flexible and thoughtful about where to take advantage of opportunities in fixed income. You're having a dispersion of global economic growth that you haven't really seen before, where the US economy is moving along in not quite a robust growth manner, but pretty well, relative to the rest of the world. You also have a real risk in Europe and Japan that we enter a deflationary cycle.

So, what do you do with that? You take interest-rate risk in parts of the world where you think interest rates have to stay low, i.e., Europe, where rates have to stay low and policy has to be easy. Same thing in Japan. You can take more credit risk in places where, like the US, interest rates may move up.

You have to think about where you are in terms of term structure—where on the yield curve you're going to take interest rate risk; where you take credit risk; where you take growth risk. They can be very different over the next few years. And how the emerging markets play out relative to that is also very significant over the next few years. It's a very different dynamic. We've lived in a world where the global economy has generally moved together, but now you can have very significant dispersion in economic growth, inflationary conditions and what happens to interest rates, and what happens to growth and risk assets alongside of it.


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