From Bond Buying with Quantitative Easing to ECB tapering
Among the most pressing issues facing any portfolio manager are concerns of the consequences of ECB tapering.
From the financial crisis of 2008, the ECB has grown its asset holdings by some 3.2 trillion Euro, of which the bond buying program makes up for some 2.5 trillion Euro. After years of bond buying – thereby increasing demand for bonds – and in effect trillions of Euros pouring into the market. Now this 'buying spree' is about to end. The US FED had been on a similar bond buying program, which is in process of being reversed already. As the US budget deficit will most likely reach one trillion dollar in 2019, new US bond issues are expected to prevail.
The full consequences of this shift, when trillions of positive cash inflow into bond markets is disappearing, are still unknown. Less demand from bond buyers will probably add to the already steepening interest rate path. In addition, the gradual tightening of monetary policy and global trade and political conflicts will make many investors see an increasingly uncertain environment ahead.
Flight to Safety - or Just Flight Away
Most investors will examine ways how to offset, or at least reduce any exposure which is prone to take a hit by these developments. One possible approach seems to be unwinding risk. Typically reducing equity and high-yield exposure and moving into high quality bonds. Thereby prioritizing your risk budget ahead of your return target. Other investors with more strict return targets are more inclined to keep their existing exposure, thereby increasing the perceived risk level in the portfolio.
For high-yield investors, a third, yet different approach may be to seek an alternative exposure, with diversification qualities that will contribute to de-risking of the portfolio. Such an alternative has to be less affected by tapering of bond-buying programs, interest rate hikes and the consequences of large ETF flows; a flight away from these factors.
Why Going North may be a Good Way of De-Risking
No credit strategy will be unaffected by market unrest, but some markets have shown more resilience to recent volatility. One such alternative is the Nordic corporate bond market. Representing some 15 % of the total European high-yield market, many institutional investors have come to see the Nordics as very attractive: What used to be a niche segment has evolved into a well-diversified market place, offering short duration and higher credit spreads. The fact that this market is characterised by a stable economic, legal, and political framework (three countries in the Nordics are "AAA" rated), only adds to its new role within any European corporate bond exposure. In this environment of well-developed corporate governance qualities, the role of the credit analyst will be more focused, and in a position to add alpha; evaluate the business model of the issuing company and its specific credit-worthiness.