Beyond Bulls & Bears

Fixed Income

Cautious European Fixed Income Investors May be Sacrificing Yield

Central banks in many parts of the world are shifting away from the accommodative monetary policies imposed after the 2007-2009 global financial crisis. The European Central Bank (ECB) has so far remained reluctant to move down that path, but pressure is growing on its leaders to signal their intentions. As markets wait for clarity from the ECB, Franklin Templeton surveyed continental European professional investors to gauge their attitudes towards changing market tides, asset allocation and investment considerations. David Zahn, Franklin Templeton’s head of European Fixed Income, analyses the findings.

It has been well over a decade since the global financial crisis. In this time, markets have experienced a sustained period of easy monetary policy. European fixed income investors in particular have enjoyed periods of generally good returns and relatively low risks, thanks in part to the European Central Bank’s (ECB) historic quantitative easing (QE) programme and record-low interest rates.

But in 2018, we are reaching an inflection point as central banks around the world begin a slow path to reduced stimulus. As the US Federal Reserve embarks on a clear rate-hike path and starts to unwind its balance sheet, the situation in Europe is somewhat different. The ECB remains accommodative. We believe it will remain accommodative until it sees inflation in Europe at its target growth rate of 2%. We think this is unlikely to happen before 2020.

But this does not mean that European fixed income markets are safe from volatility.

Despite the ECB reiterating its policy on several occasions, we are seeing isolated selloffs in bonds occurring throughout the year as markets try to accurately estimate the timing of a change in policy. Earlier this year, bond yields across Europe rose following the January ECB announcement, despite no policy change announced.

These bouts of volatility can have a significant impact on the performance of a fixed income portfolio. For example, a 10 basis-point rise (0.1%) on a 10-year German government bond (bund) with an end-of-year yield of 0.427% would wipe out over two years of potential income.

In my view, investors can no longer afford to take a sleepy approach to their European fixed income investments. As volatility returns to the European fixed income landscape, investors may consider taking an active, dynamic and considered approach. I think those that do could find favourable buying opportunities arise through the volatility.

In order to understand more about investor perceptions towards European fixed income, we surveyed over 300 European fixed income professional investors from France, Germany, Italy and Spain on their attitudes and concerns towards the changing market tides, their asset allocation and investment approach1.

The results were surprising and generally showed that investors were being overly cautious in the management of their portfolios and expressed a generally low risk appetite. Despite this, when they did take risk, it tended to be in high-yield credit instruments, despite fears of stretched valuations. In addition, they generally did not take much action when it came to concerns around low returns, and in some cases took what we’d consider to be too much action when it came to mitigating other concerns such as interest-rate risks. In general, the key themes from the findings were:

  • Defensive positioning: Investors reported a low appetite for risk amidst concerns such as rising volatility.
  • High yield: Where investors surveyed were willing to take risk.
  • Lack of action: Despite the low yield environment, investors were still focused on core European markets with low returns.
  • Too much action: Despite thinking interest rates will stay low in Europe, investors surveyed said they were reducing duration, sacrificing precious yield.
  • Future trends: Respondents reported emerging appetite for “green” bonds, socially responsible investing (SRI) bond funds and impact-investing funds.

To read or download the full report visit: http://www.franklintempletonglobal.com/european-fixed-income-study-2018 

The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments.

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1. Franklin Templeton European Fixed Income Investor Attitudes, Concerns and Actions 2018. The survey was conducted among a sample of 320 professional investors (advisers and discretionary fund managers) in four European countries: France, Germany, Italy and Spain. The survey was administered during January 2018, by CoreData Research.

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