Last updated: 09:39 / Wednesday, 13 July 2016
According to AB

Three Reasons Not to Boot Your Bonds After Brexit

Three Reasons Not to Boot Your Bonds After Brexit

As the dust settles, and the house of Commons schedules a hearing on September 5th, to discuss the possibility of a second Referendum, AB's Paul DeNoon, Director—Emerging-Market Debt, Scott DiMaggio, Director—Global Fixed Income and Canada Fixed Income, and Gershon Distenfeld, Director—High Yield and Investment-Grade Credit, offer three reasons you shouldn’t “exit” your bond portfolios.

1.- Calm and Orderly Markets. A crisis? The AB specialists believe they are far from it. Political turmoil in the UK aside, most people are keeping their heads. The markets have in fact been remarkably well behaved. And the further from the center of the storm, the less the disruption. US municipal markets, for example, remained completely unruffled as events unfolded, they explain.

The UK and countries most proximate to it came under the most stress. "Riskier assets, including European high yield, were briefly down in price owing to correlations with equities. Interestingly, however, we saw no forced selling when prices dipped."

What did they see instead? Buyers. As a result, higher-yielding bonds outside of Europe have held up nicely. Even emerging-market debt weathered the situation well; that’s partly because although oil is down 4.5% in response to Brexit, other commodities such as copper are on the rise.

Already, the capital markets appear to have stabilized, they state.

The three od them believe there are critical reasons why in spite of uncertainty and political drama, the impact has been limited, rather than fueling a contagion or meltdown effect, as in 2008. "The global banking system is in far better condition now than then, thanks to increased regulation, and the derivatives market has been cleaned up as well. Together with central bank policy responses, these give investors confidence in the financial system."

2.- Credit Loves “Lower, Longer.” How long might this go on? The UK must trigger Article 50 to start the clock on exiting the EU. From then, the exit process will take another two years, though that could be extended. Prime Minister Cameron says he will leave triggering Article 50 to the next prime minister.

"To the extent that Brexit creates economic and financial market uncertainty for an extended period, the Federal Reserve and other central banks distant from the epicenter are likely to remain accommodative for longer. And make no mistake: there will be a central bank policy response around the globe—one that we believe will be enough to offset the growth shock in the UK. But that’s not bad news for investors." the AB directors state.

"Over the longer run, slower growth and interest rates that remain lower for longer may prove helpful to credit markets outside Europe. While recession is bad for credit markets, so too is rapid growth, which leads to rapid tightening. The sweet spot? Slow growth, which keeps central banks in low-rate territory."  

3.- You Kept Some Powder Dry. DeNoon, DiMaggio y Distenfeld recall that during times of market stress, investors who have kept cash on the sidelines can snap up attractively priced securities before they’re bid higher again.

Over the last few days, opportunities sprang up in commercial mortgage-backed securities and the financials sector. In their opinion, investors who either felt too risk averse to take on new positions during that time, or would have had to sell positions at low prices in order to buy new ones, missed out.

"Savvy global core investors—those who invest in global bonds as a strategic offset to risk assets—also came into Brexit currency-hedged, and will stay that way." During the flight to safety, currencies close to the center of the storm fared poorly, but the US dollar, yen and Swiss franc did well. As a result, even a UK bond position performed well in portfolios that were hedged into US dollars they point out.

"There’s no question that the global bond markets saw exaggerated price movements following the Brexit referendum, particularly in the UK and the rest of Europe. And we’re continuing to closely monitor the situation. But we’ve not observed stress in the short-term funding markets, forced selling by risk-parity strategies or panicked investor outflows. On the contrary, investors hold core bond or high-income portfolios for specific investment reasons—reasons that still hold true today. As long as bond portfolios maintain adequate liquidity in the face of volatile markets, the Brexit experience shows that it pays to keep bonds on board." They conclude.