Fixed income review & outlook 2015

International Fixed Income: Value amidst diverging markets Amidst a benign USD interest rate environment and continuing accommodative policy by the US Federal reserve, bond market performance was driven predominantly by country-specific and non-interest rate factors. Emerging market bonds surrendered considerable returns accumulated through 2014 over the past two months. The asset class provided a total return (price and interest gains) of 3.6 per cent year-to-date, after peaking at 8.65 per cent in August 2014. The bonds of the largest emerging market economies (Brazil, Russia, India and China) have endured differing performances throughout 2014. Election outcomes, global economic indicators, geopolitics and volatile commodity prices have all influenced emerging bond markets and its constituents. With West Texas Intermediate crude oil prices falling over 45 per cent year-to-date, Brazilian and Russian investment grade bond prices (among other oil exporting EM countries) have retreated between seven to 15 per cent year-to-date. Adding to weak bond performance in these countries have been mixed election outcomes (Brazil), on-going geopolitical tensions in the case of Russia and sluggish economic activity. In comparison, the bonds of oil-importing countries (such as India and China) have performed well. Continued economic growth has also kept investor interest in these countries bonds strong. 

Table 1 
Note: Total return refers to capital appreciation plus distribution (dividends or coupon payments).

2015 Opportunities 
Following the US Federal Open Market Committee’s ending of its Quantitative Easing Programme, the Fed has indicated its intention to gradually raise key interest rates in mid-2015. With US inflation rates remaining low, however, the proposed rate hike may be initiated later in the year. For most EM bond issuers, commodity prices will continue to influence fixed income performance. The investor with a medium-term outlook may now be presented with attractive entry points into some of the higher quality names across the EM bond space. Similar to previous articles, lower oil prices could present opportunities for investors to take advantage of lower prices/higher yields in energy and mining companies with good credit profiles.

Local Fixed Income Outlook
2014 presented public investors with limited opportunities in the TTD space. There was little to excite the TT-dollar bond investor. Two GORTT fixed rated bonds were auctioned. The first was a $1 Billion seven-year bond issued in June at a coupon of 2.2 per cent, a price of $101.30 and 2 per cent yield to maturity. The second was a $1.45 Billion 12-year bond issued in September at a coupon of 2.8 per cent and a price of $96.04 and 3.2 per cent yield to maturity.
Looking ahead, the Central Bank has signalled to the local capital markets that interest rates should be higher to incentivize TT-dollar bond investors. Their policy initiative of increasing the TTD repo rate will likely have a more pronounced impact on local lending rates, as opposed to pushing deposit rates and bond yields up. (See Exhibit 1) With excess liquidity averaging $6.7 billion as at October 2014 and a relative scarcity of TTD fixed income assets, deposit rates and yields are likely to remain at or near historical lows in the near term. Should low oil prices persist for an extended period, GORTT may find it necessary to access local bond markets to finance its budget needs. In such a scenario, yields on TTD bonds could be pushed upwards. 

(Exhibit 1)
One upcoming local bond market development relates to the issuance of bonds to the Hindu Credit Union (HCU) members. Prior statements would have indicated that they would have been issued towards the end of 2014, however as we close the year, early 2015 may be a more likely timeframe. Approximately TT$500 million in 1-20 year government bonds should be issued to former holders of deposits at HCU, who would have the option of either holding these bonds to maturity or selling them to market players, which market participants such as Bourse could facilitate. 

Investor Considerations
In keeping with our investment themes for 2014, investors should seek to target positive, inflation adjusted returns. This objective can be achieved if investors look externally to emerging market USD denominated securities with investment grade quality. On an inflation-adjusted basis, TTD bonds are yielding negative real returns. 
As the serious investor looks to build a real income generating portfolio, he/she must look to broaden the investment horizon into the USD fixed income space. Earlier on in the year, we had indicated that investors can attain approximately a 4.5per cent yield on emerging market investment grade bonds. Depending on an investor’s risk profile, they can now attain yields in the range of 5-6per cent on USD bond investments in the 5-10 year bond space. Exhibit 2 compares the returns an investor would have received in Mid-2014 to what they can currently earn as we enter 2015. USD bonds should remain a key component of any investment portfolio, providing relative stability and cash flow generation to a balanced portfolio.

(Exhibit 2)
Investor participation
In keeping with Bourse’s theme of maintaining a well-diversified portfolio, emerging markets should be an important component of any moderate to aggressive investment portfolio. Leading regional economic growth, improving market access and a favourable economic environment suggest further that the Asia region should be a healthy component of an investment portfolio. Investors can gain exposure to the Asia region through several routes, including buying individual securities and ETFs, or acquiring units of any local mutual funds which focus on the India/Asia market, including the Savinvest India Asia Fund offered by Bourse.
Next week we discuss the International Fixed Income outlook for 2015 and the hunt for yields.

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