Global fixed-income manager Western Asset Management believes the best value in the fixed-income marketplace continues to be found in corporate debt.
The rally that began in late-2008 in both the investment-grade and high-yield markets has lost little momentum during the slow months of summer. Although valuations are not nearly as attractive as they were months ago, Western Asset believes spreads are expected to continue to tighten, albeit at a much slower pace.
"Spreads have nearly compressed back to pre-Lehman levels but remain above past cyclical peaks," says Mike Zelouf, London-based director of international business at Western Asset.
Zelouf notes that the importance of subsector rotation and issue selection should rise as overcompensation for systemic risk fades, leaving "idiosyncratic risks" dominant. As opportunities arise with buoyant pricing, a gradual movement along the quality spectrum towards higher-rated issues should be considered, he adds.
"Although we continue to believe that a modest high-yield allocation can make a positive contribution, we will look to shed some exposure on select issues we feel no longer overcompensate for risks," he says. "This programme will take time as it is in its early stage and contingent on current market trends extending," he said.
Western Asset is focusing on top-tier institutions in the US and in Europe that continue to gain market share at the expense of smaller institutions.
Zelouf believes that most major economies will record positive GDP growth as production schedules rapidly improve but private sector credit extension must ultimately recover for the economy to resume its longer-term growth path. The normalisation phase in financial markets will take time, he notes, and the excess capacity that remains in the underlying economy should keep a lid on inflationary pressures in the meantime.
"Private sector banks will only gradually begin to extend credit in a meaningful way while the demand for credit will only gradually recover during a prolonged phase of household balance sheet repair," he says.
Market pricing implies possible sharp increases in government yields resulting from the inflationary effects of quantitative easing and the inability to absorb the supply of new government issuance. That said, Western Asset is opting to hold additional duration focused primarily on middle- to longer-dated issues in anticipation of flattening yield curves as market expectation of a quick tightening of monetary policy remain unrealised.
"We remain cautious on our currency strategies and will maintain our portfolio exposures close to that of their benchmarks, with only modest strategies being implemented on a tactical basis if and when we feel currency adjustments have overshot," Zelouf says.