Duration will favour government bonds in Europe as a whole, benefitting ETFs such as the Xtrackers II Eurozone Government Bond 25+ UCITS ETF (DBXG) and the Xtrackers II Eurozone Government Bond 15-30yr UCITS ETF (DBXF).
Percentage gain/loss according to a given movement in yield
|ISIN||Duration||Convexity||+/-10 bps||+/-50 bps||+/-80 bps|
Source: Bloomberg and Saxo Group.
The beginning of a new era for the United Kingdom sees upside for inflation-linked government bonds
Although Gilts in 2020 offered protection against the volatility provoked by the Covid-19 crisis and Brexit noises, this year they will suffer from an identity crisis. On one side there are expectations of an economic rebound due to the rollout of a vaccine and a Brexit deal; on the other we have tighter lockdown measures imposed in the wake of a third Covid-19 wave, and the uncertainty of how the British economy will fare without the European bloc. As a consequence, sentiment in Gilts will remain mixed before finding a proper direction. A neutral stance will be the most appropriate strategy for the first quarter of the year. At the same time, it is important to monitor how the economic backdrop develops. A large part of the market expects a rate cut from the Bank of England that will push nominal yields lower, but if inflationary pressure arises, it will be unlikely that the BOE will embark on this journey, leaving yields free to rise.
The indisputable trend that we will witness in the sterling bond space will be a steady fall of real yield. Higher nominal yields will not match higher inflation expectations, as policymakers will try to keep borrowing costs lower for longer to kickstart growth. In this context, it is crucial to reduce weight on nominals and enter inflation-linked bonds, or ETFs which track inflation such as the Lyxor ETF iBoxx U.K. Gilt Inflation Linked (GILI).
Another way to reduce the risk of falling real yields is to buy higher-yielding security. However, sterling spreads have tightened below pre-pandemic levels, meaning that credits are more expensive than a year ago despite carrying higher default risk. Rather than buying into a single name, investors could consider entering in high-yield corporate ETFs such as the iShares Global High Yield Corp Bond (GHYS), in an effort to ensure diversification.
Green bonds will continue their rise
Governments and corporates are expected to issue $500bn in green bonds this year, which is more than double the amount issued in 2020. Governments will be inclined to increase investments in this sector, as studies have found that green infrastructure investment creates more jobs than other traditional investments.
Green bonds represent the perfect opportunity for investors to diversify their investments into a new sector about to flourish. It is particularly true for euro-denominated green bonds, as interest rates will remain low for longer. Regarding US dollar-denominated green bonds, investors should cherry-pick and beware of duration, as already explained above. At the moment, corporate green bonds offer a pickup of around 80 basis points over their benchmark both in the United States and Europe, which unfortunately doesn't give enough protection against rising yields in the US.
Sovereign Bond ETFs
U.S. Treasuries ETFs
|iShares USD Treasury Bond 20+yr UCITS ETF||TLT||USD||Underweight||Yes||18.2%||38.5%|
|iShares USD Treasury Bond 20+yr UCITS ETF||DTLE||EUR||Underweight||No||15.2%||18.8%|
|iShares Barclays 10-20 Year Treasury Bond Fund||TLH||USD||Underweight||Yes||13.8%||26.4%|
|iShares Euro Government Bond 10-15yr UCITS ETF||IEGZ||EUR||Underweight||No||6.7%||24.6%|
|iShares USD Treasury Bond 7-10yr ETF ||IEF||USD||Underweight||Yes||10.0%||21.2%|
|iShares USD Treasury Bond 7-10yr UCITS ETF ||IBCM||EUR||Underweight||Yes||4.0%||15.7%|
|iShares USD Treasury Bond 1-3yr UCITS ETF||SHY||USD||Neutral||Yes||3.0%||8.2%|
|iShares USD Treasury Bond 1-3yr UCITS ETF||IUSU||EUR||Neutral||No||-6.0%||-6.3%|
|iShares Barclays TIPS Bond Fund||TIP||USD||Overweight||Yes||10.4%||20.6%|
|iShares USD TIPS UCITS ETF||TPSA||EUR||Overweight||No||1.2%||4.6%|
|PIMCO 15+ Year US TIPS Index||LTPZ||USD||Overweight||Yes||23.5%||43.2%|
|PIMCO Broad U.S. TIPS Index Fund||TIPZ||USD||Overweight||Yes||10.7%||21.0%|
European Government Bonds ETFs
|Xtrackers II Eurozone Government Bond UCITS ETF||DBXN||EUR||Overweight||Yes||4.6%||14.9%|
|Xtrackers II Eurozone Government Bond 25+ UCITS ETF||DBXG||EUR||Overweight||Yes||16.2%||55.2%|
|Xtrackers II Eurozone Government Bond 15-30yr UCITS ETF||DBXF||EUR||Overweight||Yes||11.4%||38.9%|
|Xtrackers II Eurozone Government Bond 7-10yr UCITS ETF||DBXB||EUR||Overweight||Yes||4.2%||16.0%|
|Xtrackers II Eurozone Government Bond 5-7yr UCITS ETF||DBXR||EUR||Neutral||Yes||2.8%||8.9%|
|Xtrackers II Eurozone Government Bond 3-5 y UCIT ETF||DBXQ||EUR||Neutral||Yes||1.5%||4.3%|
|Xtrackers II Eurozone Government Bond 1-3 y UCIT ETF||DBXP||EUR||Neutral||Yes||0.1%||-0.6%|
|Xtrackers II Eurozone Government Bond Inflation-Linked Bond ETF||DBXK||EUR||Neutral||Yes||2.7%||11.3%|
|Multi Units France Lyxor ETF IBOX £ GILTS||GILS||GBp||Neutral||Yes||8.3%||26.0%|
|iShares UK Gilts 0-5 yr UCITS ETF||IGLS||GBP||Neutral||No||1.5%||4.2%|
|iShares Core UK Gilts UCITS ETF||IGLT||GBP||Neutral||No||8.4%||25.7%|
|Lyxor ETF iBoxx UK Gilt Inflation Linked||GILI||GBP||Overweight||No||11.0%||41.1%|
Source: Bloomberg and Saxo Group
*Table shows 5-year total return or since inception
Energy bonds to benefit from reflation
The recent wave of Covid-19 cases has slowed down economic activity, disrupting demand and prices for crude oil and fuel once again. Although the market is fast in envisioning a renewable era, the transition to green will be gradual, and in the foreseeable future we will still need to rely on the traditional energy sector. Thus, a considerable part of investments will need to continue to flow to sustain existing energy supply levels. Governments will need to continue to support struggling energy companies through stimulus packages to ensure that there will not be disruption to economic activity. Once the economy is on a stable path to recovery, we can expect energy demand to be restored and the sector to recover quickly.
The bond market offers many opportunities within this space; however, it is crucial to cherry-pick. Energy companies with a contained net debt to EBITDA will be able to weather depressed energy demand spurring from low economic activity. At the same time, state-owned companies will be better positioned to take advantage of stimulus packages. In a previous analysis, we found exciting opportunities within Lukoil, Gazprom and Ecopetrol, which offer competitive yields for their notes. On the other hand, while Pemex offers one of the highest yields in this sector, the company is poised to suffer together with Mexico's government bonds from a massive debt burden, and a dependency on the capital market to service its debt.