In our previous article, we highlighted the implications of the recent slowdown in global growth within financial markets. Weaker-than-anticipated economic data coming out of the three largest economies globally; the United States, China and Japan, surges in oil and food prices, disruptions in the global supply chain owing to the Japanese catastrophe and the European debt crisis have magnified concerns about the "soft patch" in global growth.
Increased fragility in the global economy led to a fall in investor confidence, and with the increase in risk aversion, stock markets globally have declined. In uncertain times such as these, most investors prefer the stable and predictable returns associated with fixed income instruments. In this piece, we will explore the fixed income assets available to risk averse investors both in the local and international bond markets.
Bonds vs Equities
An International Perspective
The equity market is generally more sensitive to economic conditions and market sentiment than bonds and other fixed income securities. The major stock markets globally have been experiencing heightened volatility year-to-date owing to the slowdown in growth as illustrated in Figure 1. The MSCI World Equity Index, the S&P 500 Index and the MSCI Emerging Markets Index peaked in May, having increased by 8.06 per cent, 7.03 per cent and 3.69 per cent respectively. However, following this climax, equity markets began to decline in wake of decreasing investor confidence.
In the month of June, the MSCI World Equity Index fell by 5.2 per cent, while the MSCI Emerging Markets Equity Indices and the S&P 500 declined by 3.5 and 6.3 per cent. In contrast to equity markets, fixed income instruments have performed steadily over the same period. Year-to-date, the global bond market performed favorably and experienced more positive returns relative to equity markets. The US Treasuries Total Return Index increased by 3.1 per cent while, the JP Morgan US Aggregate Bond Index and JP Morgan Emerging Markets Bond Index increased by 3.47 and 4.10 per cent respectively year-to-date (Figure 2).
Choosing the right Fixed Income Instrument
Local US$ money market mutual funds and repurchase agreements are suitable to investors who are willing to invest in the short term. On average, US$ money market mutual funds generated a return of 2.53 per cent in May. Money market mutual funds are relatively safe and liquid instruments, however, their distribution rates are not fixed and tend to be lowered (or raised) at the fund's discretion. It should be noted investors can earn similar or superior returns by investing in short term repurchase agreements (repos). Repos can be used by investors to diversify their portfolio and are less risky than unsecured short term deposit facilities since they are backed by suitable securities.
Investors can earn even more substantial returns by extending their investment horizons in the medium term (3.0 to 7.0 years). Some emerging markets are preferred investment destinations, especially those possessing high growth rates, low debt to GDP ratios and high levels of foreign currency reserves.
For investors who are willing to seek attractive returns abroad, there exists a multitude of investment grade bonds which can offer competitive returns. Sovereign bonds possess relatively low default risk and may be suitable to investors with high levels of risk aversion.
Of course, the corollary is the relatively low rates of return associated with sovereign bonds. Investors may also consider bond issues from quasi-sovereign corporations which possess some degree of government ownership. For instance, Russian quasi-sovereign companies; Gazprom and VTB Bank are of investment grade quality holding BBB (S&P) credit ratings and offer attractive returns.
Gazprom's 2016 bond and VTB Bank's 2015 issue, which matures within 4.0 to 5.0 years, provides a competitive yield of about 4.0 per cent to investors. For investors with higher risk appetites, corporate bonds rated just below investment grade are worthy of consideration. India's Vedanta Resources 2014 bond and Sagicor 2016 issue may be considered by investors owing to their attractive yields and medium term tenor. Vedanta 2014 bond has a relatively short maturity period of 3.0 years and offers a yield of over 4.00 per cent, while the Sagicor 2016 generates a return of approximately 5.60 per cent.
Local Investment Opportunities
The local bond market remains muted with only one quasi-sovereign issue for the year, National Insurance Property Development Company (Nipdec) TT$ 750 million 6.55 per cent fixed rate bond due in 2030. Year-to-date, tighter liquidity conditions in the short term and the increase in Treasury Yields resulted in an upward shift of the yield curve over the short and medium term.In June, the yield on the three month Treasury Bill increased to 1.00 per cent from the 0.36 per cent yield experienced in January. However, the longer end of the yield curve remained relatively unchanged year-to-date as Figure 3 depicts. Local TT$ money market mutual funds continue to offer short term investors higher yields than local commercial bank deposit rates. In May, the average return of TT$ money market mutual funds was 2.06 per cent.
Conclusion
The slowdown in global growth has resulted in increased volatility in financial markets globally. To weather uncertain times such as these, investors can consider the stability of cash flows associated with fixed income assets. International markets provide numerous high quality sovereign and corporate bonds. These bonds are available in various tenors and geographical areas for investors with varying levels of risk aversion. Yet again, we recommend investors should seek advice from a qualified investment advisor before undertaking investment decisions.