Investors warned to review portfolios post bond sell-off

Asset owners should be re-assessing their portfolios in light of last week's sharp sell-off in US government bonds amid fears of a quicker end to quantitative easing and that the bond bull market could be ending, investment specialists have warned.

With US Treasury yields now likely to climb higher than expected this year, investors with large fixed income allocations could see a significant decline in the value of those holdings if they haven’t started to take precautionary measures, experts said. When bond yields rise, their prices fall.

“We have already looked to advise [institutional investors] to position their portfolios to provide greater protection against rising yields and to increase diversification,” said Paul Colwell, director of investments for Asia at consultancy Willis Towers Watson. This is because US bonds tend to be the main defensive portfolio allocation for most asset owners in Asia, he told AsianInvestor.

A sharp sell-off on January 10 saw yields on 10-year US government bonds spike from 2.49% to 2.55%, a level not seen in nine months, on investor fears that central banks would move more aggressively than anticipated to end its monetary stimulus programme. They were yielding 2.55% as of yesterday evening (January 17) in Hong Kong, according to Bloomberg.

Proposed US tax cuts are also expected to drive growth and inflation higher, adding pressure on the Federal Reserve to raise interest rates faster than expected.

Those fears were further fuelled by experts such as bond veteran Bill Gross of fund house Janus Henderson being quoted as saying that the US Treasury market has entered a bear market, though not a dangerous one for investors.

Indeed, a global survey by Natixis Investment Managers in December showed that 62% of institutional investors saw interest rate rises as a top portfolio concern for 2018 – a potential trigger for a correction in fixed income values.

Given the uncertainty around US inflation and interest rates, experts believe the market turbulence could continue. “The 10-year yield could rise to 2.7-2.8% later this year,” said Jean-Charles Sambor, London-based deputy head of emerging market debt at BNP Paribas Asset Management.

“Nevertheless," he told AsianInvestor, "we don’t think a massive bond sell-off is on the cards as yields are extremely unlikely to go much higher than 3%.”

Isaac Poole, head of capital market research for Asia Pacific at Willis Towers Watson, also expects US Treasury yields to rise in the near term and thinks investors have not fully priced in the likely US rate hikes over the next two years. 

Late last year, several investment managers were expecting 10-year Treasury yields to sit between 2.4% and 2.6% through 2018. 

Asian bonds a good bet?

Colwell said some investors had responded by reducing portfolio duration via an allocation to cash, as well as increasing allocations to Asian bonds, which offer higher yields and shorter duration. Such moves have tended to focus mostly on dollar-denominated Asian corporate bonds, he added.

For instance, yesterday (January 17), India's 10-year sovereign bond yields stood at 7.22%, and Indonesia's at 6.06%, according to Bloomberg. 

The key risk to Asian bonds is that yields could be forced higher if there is a disorderly sell off in the US, said Poole of WTW.

“We think this would require a sharp and unexpected surge in inflation. But while US inflation is recovering, it is more likely to grind higher, leaving a relatively benign outlook for Asian bonds."

Consumer price inflation in the US is expected to average 1.8% in 2018, according to a January 11 note by Invesco.

Moreover, Poole doesn’t expect Asian central banks to be pressured to hike rates in sync with the US Fed.

However, some experts advised caution before piling into Asian or emerging-market bonds.

“Yield differentials remain attractive [for such instruments], but as monetary settings further adjust, expect some concerns on capital flight to re-emerge, while the strengthening of emerging market currencies could re-ignite ‘currency wars’ rhetoric,” said Dwyfor Evans, head of Asia-Pacific macro strategy at State Street Global Markets in a note on January 16.

“EM central banks and governments look to have a slightly more challenging environment to navigate this coming year,” he wrote.