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Buy short-dated bonds to generate returns in a divergent world: Payden & Rygel

US fund manager Payden & Rygel advises investors to buy the front end of the bond yield curve. Photo: Jessica ShapiroThe risks of global deflation and recession are overstated, and investors should get ahead of the bond yield curve in order to generate positive returns in an environment where yields will remain challenged, a United States bond fund manager says.

Brad Boyd, senior vice-president at Los Angeles-based US investment firm Payden & Rygel, said while fears abounded about the decline in manufacturing, it made up just 16 per cent of the world economy. Adding to the reasons for optimism was that consumption was improving, oil was trading at its historical average and China’s slowdown was consistent with its transition and at a respectable 5 per cent.

But unprecedented central bank intervention, including zero interest rates and now negative interest rates, as well as the US Federal Reserve’s “awakening” meant traditional bond markets are likely to remained challenge for years to come.

“Not only do we have this environment of low prospective returns and also a thin margin for error, you have a wide range of places to invest with a wide range of potential outcomes,” Mr Boyd said at an investment outlook briefing in Melbourne.

The market had all but priced out the chance for rates to rise in the US this year, but Mr Boyd said if economic data remained on track the Federal Reserve would lift rates another two or three times this year.

The challenge for investors was investing in a bond market where yields ranged from negative 0.7 per cent in Switzerland to more than 2 per cent in Australia. The best strategy was to trade at the front end of the yield curve, or the short-dated maturities, in anticipation the stronger economy would see bond prices rise, he said.

Charlie Jamieson, executive director at Jamieson Coote Bonds, said he expected the rally in Australian bonds to continue.

Long-dated 10-year bond yield fell to 2.34 per cent, their lowest point in 10 months last week as the equity market dove into a bear market. Yields have rallied in the past two days .

Mr Jamieson said the bond market moves were a “sinister” warning of things to come.

“We know things like the Chinese slowdown are an issue … it’s a very known risk but we just don’t know the full  implications of that until we pass through the ring of fire,” he said.

Bonds yields jumped off their 10-month low on Friday in a return to risk appetite driven by an 11 per cent recovery in Deutsche Bank shares on news of its $5 billion debt buyback, and a 10 per cent surge in oil.

“There is no reason to think the bond market pricing isn’t justified,” he said.

He said investors knew they were “sailing into the wind” this year and any inflation shocks would be to the downside.

Clime Asset Management chief investment officer John Abernethy, however, urged investors not to panic. He advised buying shares in bouts of weakness, and historically the equity market provided a “far superior” return compared to the Australian bond market.

“Low returns will flow to those that panic, while higher returns will be gifted to those that don’t.”

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