In this fixed income market intelligence column, our experts discuss whether it's better to be invested or not to be invested.

1. Fixed income: to be or
not to be invested
Jaco Rouw
Senior Portfolio Manager Global Fixed Income
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2. For several years one question has been asked again and again – whether one should (still) be invested in
global fixed income. The reasons to be cautious about the outlook for global bonds can be grouped into three
main categories.
The first reason to worry is that global bond prices have been going up
for a long time already, so at some point they must start to come
down. It’s true that asset prices are unlikely to go up forever, but as
can be seen in the chart below, the same conclusion could have been
drawn five, ten or fifteen years ago.
What goes up must come down?
Having said that, the continued decline in global bond yields over the
past few decades has been fascinating. One explanation for this
decline in yields is a revival of the notion of ‘secular stagnation’,
whereby the underlying problem is that the real interest rate that
balances savings and investment at full employment may be
substantially negative. In our view, this shift in savings/investment
balances can to a large extent be attributed to demographics. Over
the last few decades, the number of ‘prime savers’ (roughly between
the ages of 25 and 65) as a percentage of the total population has
increased steadily, resulting in high desired savings relative to
investments. At this moment, however, the ‘prime savers’ population
shift is largely over, suggesting the decline in global rates might be
nearing its end.
A second reason to worry is that for fixed income, higher prices mean
lower yields, and yields cannot drop below zero. At least, that is what
we thought until recently. Currently, around 20% of the Euro
government bond indices carries a negative yield. Early this year, this
number was even close to 30%. Still, yields are very low, and at around
1.7% – the current yield on the Barclays Global Aggregate index – the
upside for yields (or downside for prices) seems far higher than the
reverse. There is some truth here, but one should remember how at the
start of this century, Japanese 10-year yields at 1.8% were seen as
‘ridiculously’ low. In the next 15 years, Japanese 10-year yields rarely
traded above 1.8%. With the benefit of hindsight, we all understand
that economic fundamentals were justifying these low bond yield
levels.
This brings us to the third reason: valuation. This seems the only
correct way to assess the outlook for global fixed income.
Unfortunately, it is also the most subjective one. Even without
Quantitative Easing, models based on traditional inputs like economic
growth, inflation and official policy rates are likely to come up with
different fair values, depending on one’s views on these variables. Next
to that, by how much should fair value yields be lowered because
government bond supply minus central bank buying in the four major
developed economies will be nearly flat in 2015, the smallest number
since early this century?
Adding it all up, we only see modestly higher bond yields for the next
six to twelve months. The long-term demographic trend is likely to turn
from bond positive to bond negative, but this is a very gradual process,
and not something that is going to push up bond yields sharply next
year. Furthermore, we acknowledge that bond yields are very low, but
that there are good reasons why the ‘low for longer’ environment can
persist – massive bond buying by central banks being one of these
reasons.
Finally a word on one of the main worries of the financial markets –
Fed rate hikes. We like to stress that the impact of Fed rate hikes
should not be over-estimated. For example, the Fed is likely to raise
rates when the economy is doing well, which is a positive for corporate
spreads. Assuming that US 2-year swap rates – a proxy for Fed fund
expectations – will rise by 250 basis points in the next two years, the
yield on the Barclays Global index is likely to go up by around 1.0%,
based on historical relations. Including carry, this results in a total
return of -1.0% per year. Bad, but not disastrous. Any bond fund with a
more aggressive active return profile should be able to get the total
return back into positive numbers.
Jaco Rouw
Senior Portfolio Manager
Global Fixed Income
Barclays Global Agg (USD, hedged)

3. About NN Investment Partners
NN Investment Partners is the asset manager of NN Group N.V., a publicly traded corporation. NN
Investment Partners is head-quartered in The Hague, The Netherlands. NN Investment Partners
manages in aggregate approximately EUR 184 bln* (USD 206 bln*) in assets for institutions and
individual investors worldwide. NN Investment Partners employs over 1,100 staff and is active in 16
countries across Europe, Middle East, Asia and U.S.
As of April 07, ING Investment Management has renamed to NN Investment Partners. NN
Investment Partners is part of NN Group N.V., a publicly traded corporation. Currently NN Group is
37.1% owned by ING Group. ING intends to divest the remaining stake in NN Group before 31
December 2016, in line with the timeline ING has agreed with the European Commission.”
*Figures as of 30 June 2015
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