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Flows in reverse

After few years of record flows, riskier fixed income assets like investment-grade credit, high yield and emerging markets debt have suffered their worst ever start to a year. Month-to-date, there have been outflows from all three categories. This may be because the market has got better at pricing risk.

The hunt for yield has pushed investors to greatly increase their exposure to credit and EM debt over the last few years. For a time that served them well, but the wind seems to be changing and an increasingly lengthy list of worries suggest the bull-run for these assets may now be behind us. 

Risk premia indicate credit is expensive compared to almost all asset classes. Rising rates mean we are nearing the point at which holding credit is no longer a pre-requisite for covering contractual obligations. In Europe, no marginal buyers seem to exist to replace the ECB when it stops purchasing credit this coming September. Interest rate rises and a re-pricing of risk could weigh on emerging debt.  

A miserable start to 2018            


MTD EURM YTD Flows
Investment Grade

tiller-1206

tiller-1186 


Negative since mid-January

High Yield 


tiller -62


tiller-1240

Negative since end of January
Emerging Market Debt

tiller-444 


g tiller  -268


Negative at the beginning of March

Source Lyxor Bloomberg as of 31/03/18

Follow the money with our flows tool 

What’s next? 

We share the view of those more wary investors. Sovereign bond yields are rising, so we find credit less compelling, both in Europe and the US. Should you have to hold credit, we prefer European over US markets and high yield over investment-grade.

European credit still has six months of ECB support left before the CSPP comes to an end. The cyclical upswing in the economy is also at an earlier stage than it is in the US. Default rates should remain lower as a result. Meanwhile, high yield markets are less sensitive to rising sovereign yields than their investment-grade counterparts.

Moving on to EM bonds, fundamentals remain positive but complacency could be dangerous. Positioning still looks stretched. EM bonds look less vulnerable than their main developed market counterparts to policy tightening. That said, carry – rather than yield compression – will be the main contributor to returns.

As for sovereign bonds, fast-rising US Treasury yields should soon hit a ceiling of around 3% and Inflation is likely to lose steam as the cycle ages. Currently, we believe Treasuries may provide more protection than bunds should risk aversion bite. Forthcoming ECB guidance on policy normalisation may add to bond market volatility – and bunds are more sensitive to such announcements than peripheral bonds.

Spanish and Italian sovereigns may be more resilient as their higher carry continues to attract inflows. In the UK, the Bank of England is still guiding markets towards further policy normalisation with inflation still above the 2% target. However, Brexit uncertainties and a slight deterioration in economic conditions could limit the scope for a rate hike. Gilts stand to benefit most. 

5 key calls 

 All data & opinion: Lyxor ETF Research & Lyxor/SG Cross Asset Research Teams as at 12 March 2018 unless otherwise stated. Past performance is no guide to future returns.

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