Fund Manager Viewpoint: OMAM's Christine Johnson

Christine Johnson, manager of the Old Mutual Dynamic Bond fund, assesses the long-term argument for sticking with fixed income.

Every sub-culture has its own language. Prison populations and the medical profession have their own vernacular, as do teenagers and investment professionals. In these languages there are words of praise and words invented as a very specific form of insult, honed to reflect some characteristic held in low esteem by the worthy denizens of the group.

My knowledge of these terms for the criminal and medical worlds is derived entirely from the television, and as for teenagers, I have no idea. But I like to think I know a few choice terms in fixed income. Chief among those we have been hearing recently are ‘bubble’, ‘yield chasing’ and, for some protagonists, ‘yield tourists’.

Yield tourists are opportunistic visitors to the higher yielding ends of the market. Like more everyday versions, they turn up only to the top attractions, and only in high season. They buy things the locals never would and they clog up ‘normal life’ making it a struggle to go about one’s business. It is easy to disparage them as just chasing yield and responding solely to the great QE income vacuum that is being created.

And so they are, but is that so bad? Now we are enjoying a live, worked example of economic theory. Quantitative easing in its crudest interpretation has one stated aim: to make risk-free, defensive investing punitively unattractive. To force frightened capital to tiptoe out into the daylight and start taking some risks again. For capital that is still a little gun-shy, corporate credit is a nice place to start.

So here the tourists come, pouring into the safest markets first and, as each normalises, the first wave moves on to the new destination, emboldened by their experiences and hungry for more.

The tourists bring capital that locals are not prepared to provide. They invest bravely in segments that the traumatised incumbents remain wary of. In doing so they make those segments less risky. Liquidity and refinancing risk evaporate in the face of their enthusiasm. But all holidays come to an end and sooner or later it is time to go home. So where are we now? Is it the last week of August, or the first? QE doesn’t just exist as some thought experiment.

Making corporate bond yields go down isn’t the targeted outcome. The targeted outcome is to make money so cheap that risky new ventures that might once have been marginal are no longer so, but are profitable instead. This includes urging companies to expand, financed by taking on cheap debt.

So, is it working? Are we nearly there yet? Numbers from the Federal Reserve imply we are not. Income has recovered from the dark days of 2008, but borrowing has not and, indeed, continues to fall. This creates an odd paradox. Corporate fundamentals are improving, which is good news for credit investors, as less reward in the shape of lower yields is more palatable if accompanied by lower risk. The tourists might have come for the yields, but they could stay longer for the fundamentals.

But it’s not good news for the economy. Cheap money is getting stuck in the system and we are in danger of the classic liquidity trap becoming a reality. Monetary policy cannot connect with the real economy, and providing more money fails to move interest rates. We are not quite ensnared in that intellectual experiment yet.

The decline in growth has been halted. Now we need to see growth pick up. To make this happen we need the credit spread curve to follow the Treasury curve ever lower. So far, only about 60bp of the 200bp fall in yields has come from spreads: the rest has all been the Treasury market doing the heavy lifting.

That leaves credit investors treading the narrow line between improving balance sheets and weak growth: something the credit market is used to. What credit investors are less familiar with is being driven by a policy with the explicit purpose of making itself redundant. When QE transmits to the real economy, the holidays will really be over. Until then, stay invested in credit. We are all tourists now.