Graham Neilson of Cairn Capital discusses the future of fixed income market after the run of high volatility in June. The credit focused firm that runs an asset management and advisory business, discusses whether the risk/reward ratio makes investment in these assets a safe option or not.
Neilson believes demand will remain high in fixed income markets
Neilson says that the recent volatility and yield spike in bond markets was a reversion to normality and is not as dangerous as it has been portrayed. However he admits that the asymmetrically low yields have been a concern for credit investors. Neilson believes that demand will remain high in fixed income markets going forward, adding that, “the four R’s will keep investment demand for fixed income assets strong – Repression, Regulation, Risk aversion and (lingering fear of) Recession.”
Cairn Capital sees constructive opportunities of investing in areas where European banks are being incentivized to decrease exposure. In this regard, Neilson mentions the lending gap that has taken shape in commercial real estate whereby opportunities for other less leveraged lenders have increased. He says the commercial real estate senior debt is an attractive risk adjusted investment which is better than investing in corporate debt at this time. Neilson is bullish on the commercial real estate senior debt UK and continental Europe.
He also points out that the crowded positioning of investors in various credit investments, which became more vocal in Q2, resulted in the massive sell off in the investment grade bonds and high yield basket in US, Europe and emerging markets. Neilson says that the higher yields in the bond markets, thanks to Fed, have started off the second half of 2013 with a better risk/reward positioning and credit markets are looking safer going forward.
Neilson argues against QE doomsday scenario
Neilson argues against the QE doomsday scenario that critics of Fed have been touting, he says that there are indications that higher inflation is not as disruptively linked to fixed income bubble burst as has been portrayed. He gives several arguments to support his position, saying that debt servicing is more of a founding stone of developed markets’ monetary policy and is less based on an inflationary system.
He says that developed market economies are based on sound banking system that encourages lending and the economies in U.S and Europe are still a long way from getting to that point. Neilson goes on to add that inflation in commodity markets is not linked to bond markets, in fact it is negatively correlated. Even now when QE-like policies are underway in various countries, deflation remains a bigger risk compared to inflation in both developed and emerging economies.