* Duration risk is managed separately of the underlying fixed income allocation using government bond futures.
Active Asset Allocation
|Short duration||Under our central scenario, expected returns of government bonds are largely flat. However, with our negative equity beta, the short duration position is designed to protect portfolios from an environment of stronger growth and gradual normalisation of monetary policy. This position is also driven by our alternative scenarios. In our upside scenario, where actual growth improves alongside higher trend growth, bond yields would be modestly negative. We give this super ‘goldilocks’ scenario a low probability though.|
|Overweight US real estate versus government bonds||In real estate, we have rotated our overweight from Europe to the US. In an improving economy with still low rates, European real estate had done well. Since eurozone real estate now looks even more expensive versus its net asset value, we decided to take profits. In the US, valuations look attractive and demand should continue to improve given the robust labour market and other demand indicators. New supply is limited, which should also benefit the asset class. Higher interest rates are a risk, using government bonds a s a funding leg limits the duration risk.|
|Underweight US high-yield versus cash||High-yield risk spreads have narrowed narrowed and a large gap has opened between our macro-based model valuations and actual valuations. Thus, we think that US high-yield corporate bonds are overvalued. Moreover, balance sheets of US companies have worsened. The US corporate sector has increased leverage, causing debts to rise close to record levels relative to GDP. The low level of interest rates is hardly reflected in interest payments relative to cash flow.|
|Underweight HC EMD versus US Treasuries||We think that at the risk spread on emerging market debt does not properly reflect the challenging outlook for emerging markets. China’s growth may moderate further when support from monetary and fiscal stimulus fades. Commodity prices have rebounded, but are still low from a historical perspective. Leverage in many emerging economies has continued to increase.|
|Overweight LC EMD versus US Treasuries||We think valuations are more attractive for local currency bonds than for hard currency . Moreover, emerging currencies have shown upward momentum lately, which we expect to continue to support local currency bonds. Falling inflation has enabled central banks in Brazil and Russia to cut interest rates, which should be supportive of local currency bonds in these countries.|
|Overweight convertibles versus government bonds & equities||We are structurally overweight convertibles for diversification benefits.|