When it comes to disruption, people typically talk about technology and its impact on jobs, society, and the global economy. But disruption is also happening in the once sleepy world of fixed income, where several critical trends are reshaping the space.
According to Owen Murfin, institutional portfolio manager, MFS Investment Management, there are four key things to watch.
Divergent central bank policy — While the world is benefiting from synchronized global growth, says Murfin, bank policy has been far from cohesive. “All central banks are raising rates, but they’re not doing it at the same pace,” he explains.
At the same time, a shift to “unconventional politics” in some countries is ramping up geopolitical risk. What does this mean for investors? Country selection is back — particularly in emerging markets. It also means that duration is no longer a bad word — as rates rise, “people recognize the benefits of duration in a portfolio, they know it hedges against inflation, and they know it decorrelates your portfolio from credit risk.”
Canadians must also consider ways to benefit from a divergence in yield curves around the world. “When you’re investing in international bonds, don’t just dismiss them because of low quoted yields — think about it on a hedged basis,” Murfin says.
Balance sheet reduction — While the QE experiment has been largely successful, central banks are now looking to reduce the size of their balance sheets. That will have a direct effect on credit, which has, to date, been “extremely stable,” Murfin adds. Going forward, stock selection will be critical as the high-yield space becomes more vulnerable and risk builds up. Proceed with caution, advises Murfin — remember that we are in a late stage in the credit cycle.
Productivity — As population growth slows in the West and the number of people working declines, the future of economic growth is uncertain. “The one big hope for higher real yields is productivity,” says Murfin. But don’t count on it helping: “[increased productivity] does cause disruption in itself because it implies that fewer workers are needed, and, therefore, you can do more with less. And fewer wages as well.”
Technology — Murfin sees technology improving liquidity in fixed income markets, a major disruption in a space where liquidity can be challenging. Technology can give investors access to transparency and ongoing information about buyers and sellers — a big change from today’s over-thecounter approach. “I hope that technology can aim to enhance liquidity, because we desperately need it in a credit market that can quickly become illiquid,” Murfin says.