(January 21, 2014) — Investors looking for return-seeking opportunities in fixed income should consider the financial sector, according to Morgan Stanley’s asset management arm.
Speaking at a media briefing, Morgan Stanley Investment Management’s European Head of European Fixed Income Rick Ford said he was overweight financials as the return opportunities for bonds in this sector were greater than in industrial sectors. He said industrial firms were starting to move from a state of repair to one of recovery.
The opportunity won’t be around forever, however, as Ford said he expected the two sectors to converge eventually.
Asked what the signals would be of banks and other financials moving into a state of recovery, he listed financial regulators stating that institutions had enough capital on their balance sheets, assets increasing on these balance sheets, and banks talking about growth again.
“One could put forward the argument that some of the banks in the US have already repaired,” he said. “In Europe, excluding for the moment Scandinavia, it’s challenging to argue that we’re in a recovery mode.”
Other opportunities for fixed income investors included convertibles (where the bond has an equity element within it) and collateralised loan obligations (CLOs).
On convertibles, Ford said: “There’s a place for them, but it’s not a one-size-fits-all scenario. For some, where you have convertibles in which you are senior in the structure and have an equity exposure, that can be attractive.
“There’s certainly institutional interest in this, but it’s not for all. Some will find it attractive, especially in this recovery towards expansion phase, as equities will outperform the fixed income component.”
On CLOs, Ford said there was “significant demand for yield, and CLOs effectively provide a pool of assets which generate a return, often with leverage in the structure”.
But investors must understand the default risk attached to the products, and how the pool of loans is structured. “They also need to consider valuation, liquidity and diversification,” he added.
Ford also questioned experts claiming there was a credit bubble, stating that all bonds were not a homogenous group and that investors should apply stress tests to each set of fixed income assets.
“A one-year bond, if it matures at par, is not a bubble, but with a 30-year bond there is a risk that could happen,” he said.
Other risks facing fixed income investors included inflation either rising or falling to the point of deflation—“It’s interesting that Draghi referenced Japan in his last speech…it suggests inflation and deflation are being considered at the highest tables.”
In Europe, the Banks Asset Quality Review, which isn’t due for a number of months, could also cause volatility, if leaks or suggestions that any institution has problems with its assets hit the market, Ford added.
“There are also liquidity and technical risks – market moves are based on a view being better or worse than expected. Investors who are long term holders could find if prices move that it becomes challenging for them.”
Related Content: 2014: A Good Year for Illiquid Credit?