3) Consider if you want to go active or passive
The S&P Dow Jones Indices SPIVA report card suggests that the average active fixed income manager does not beat a passive fixed income fund that is weighted by market capitalisation.
James Rieger, global head of fixed income at S&P Dow Jones Indices, was keen to point out that this SPIVA evidence comes in spite of bond traders and managers having access to the best expertise, data and systems.
“Actively run fixed income portfolios do not outperform the market as measured by the market weighted indices. It’s counter intuitive, but they don’t,” he said. “The timing of bond selection often disrupts returns and moves returns away from the market.”
4) The market is pricing in a global deflationary environment
Bond yields are low, relative to history. But US Treasurys are priced fairly from a global yield perspective, argues Orhan Imer, senior portfolio manager, head of inflation, liability-driven investment and fixed income index solutions at Columbia Management.
To assess yield, investors have to decide what the market is currently pricing in. The market is pricing in a global deflationary environment, according to Imer, as the European Central Bank (ECB) starts to buy sovereign bonds as part of its quantitative easing program.
“The question is: to what extent are investors at risk if central banks create inflation or make the markets believe there will be future inflation?” he said.
After all, the ECB would like to create expectations of inflation, as that would encourage spending and kick-start growth in the lagging economy. Therefore investors should expect the yield curve to steepen in future.
“Bond investing is all about weighing risks against return,” Imer said. “What’s already priced in or not in the market is the question.”
Meanwhile the Fed doubts it will hit its target of 2 percent inflation, therefore investors are paying a premium to protect themselves against deflation.
Steve Sachs, head of capital markets at ProShares, said that markets are trying to price in whether or not the U.S. is following Japan's path to deflation.
“You need to manage expectations – volatility in this asset class is on the rise, not the decline,” he warned. “The buzzword for 2015 and beyond will be risk management. We are shifting from a world over the last five years where we were chasing beta – or yield in the bond markets – to a world we are chasing alpha – outperformance – in a rising rate environment.”