Bonds are currently virtually the most expensive in history as the global asset class, with average global bond yield to maturity – the key indicator of bond attractiveness – now standing at just 1.14%, according to Bloomberg, and remain close to the historical low from August last year, even after this year's bonds’ correction. The average real global bond yield to maturity, i.e. adjusted for the inflation rate, therefore remains relatively deeply negative at -1.5%. Therefore, I continue to believe that government bonds of relatively risk-free countries do not offer much room for solid appreciation in the medium term of the next five years, including Czech government bonds.
Within the risk management of bond portfolios, interest rate risk management is key. Simply put, with bond corrections, bond prices with longer maturities tend to fall more. Under otherwise the same circumstances, it is true that an increase in the required yields to maturity, say by one percentage point, will cause a much larger decline in the price of a bond with a 10-year maturity than a bond with a 2-year maturity, for example.
The key to managing the interest rate risk of the bond portfolio is the so-called duration, which indicates the sensitivity of market prices of bonds to the movement of interest rates, respectively the required yields to maturity. At the same time, it is true that the lower the duration of the portfolio, respectively the shorter the average maturity of the bond portfolio, the lower the interest rate risk present in the portfolio. For example, for our main bond fund – Conseq Invest Bond Fund – the portfolio duration is only 1.8. In contrast, the duration of the benchmark is significantly higher at 6.6.
This fact leads to the key conclusion that in the case of the rise of the required bond yields to maturity, respectively the decline in bond market prices, our fund will suffer much less than the benchmark. After all, we have been witnessing this development since the beginning of this year, when our bond fund significantly exceeds its benchmark. Of course, underweight in duration will not completely protect our bond portfolios from a decline, however, at least compared to benchmarks, this very defensive set up will mean a very significant relative outperformance of our fund.
And as for corporate bonds, they are also rather expensive at the moment, as so-called credit margins, or risk spreads, which measure the yield premium on corporate bonds versus relatively risk-free government bond yields or interest rate swap rates, are well below historical averages. However, our active management of corporate bond portfolios is also set relatively defensively in terms of credit risk. In the case of corporate bonds with a non-investment speculative rating (high-yield), we focus mainly on companies that are not extremely over-indebted, for example by net debt/EBITDA ratio, and companies that generate very solid cash flow, for example by operating cash flow/invested capital ratio. Therefore, I dare say that our very robust credit analyzes should help prevent a significantly above-average occurrence of problematic issuers.
Michal Stupavský
Investment Strategist at Conseq Investment Management, a.s.