Government bond investors are now “boiling frogs” amid yield squeeze, says Algebris macro chief

Government bonds

Alberto Gallo, head of macro strategies at multi-strategy credit and equities hedge fund Algebris Investments, has compared investors in government bonds to “boiling frogs” who risk seeing their returns “wiped out” from future inflation rises.

As government bonds increasingly offer “return-free risk”, investors should look to alternatives, said Gallo, who is also portfolio manager of Algebris’ Global Credit Opportunities Fund.

Speaking on a recent Algebris Investments’ podcast, he noted that of the EUR70 trillion of sovereign and corporate debt in the world, just one-tenth yields more than 3 per cent.

In contrast, he pointed to a mix of credit, particularly in Europe, along with inflation-linked debt, convertibles, and certain precious metals, as offering improved yields for investors.

“If you’re buying government debt, you’re getting a return-free risk. You’re getting between zero and 1 per cent nominal yield but very likely inflation is going to erode that yield. So you have to look for alternatives.”

As yields have plummeted to record lows following sustained central bank intervention since the 2008 financial crisis, fixed income investors are now faced with two choices.

“You either accept very low yields on government debt, close to zero, so that any rise in inflation would wipe out a year of returns or more, or you go into riskier debt,” Gallo said. “In that case you have to deal with potential default risk, or volatility, or currency risks.”

He added: “That’s why government bond investors today are a boiling frog.”

Gallo - whose credit opportunities hedge fund strategy trades bank debt, sovereigns, and investment grade and high yield corporate debt – believes investors need to become “increasingly selective” in assets as they are forced towards riskier investments.

While investors shunned European assets in recent years, he described the EU’s recent approval of a EUR750 billion rescue fund as a “game changer” for European credit, equities and the euro.

“We like European credit and European equities, which are still unloved, and which investors have not been buying over the last few years,” he observed.

On the flipside, US credit and equities are less favoured by Algebris’ strategies. The country has struggled to tackle the coronavirus pandemic, which has flagged up stark inequalities between rich and poor, he observed. And with the Trump administration lagging the Democrats in opinion polls, he hinted at rising volatility as the presidential election nears.

“We prefer Europe across the globe over the US and emerging markets, but we still find value in some pockets of emerging markets,” he said.

He pointed to investment grade and high-yield debt, which offers yield ranging from 4 per cent to high single digits, particularly in weak companies in cyclical sectors based in strong countries.

Elsewhere, convertibles and select positioning in gold and silver offer opportunities, as well as inflation-linked debt. While inflation rates are still depressed by the virus and by the recession, they may recover, with virus-struck economies aided by the EU’s EUR750 billion rescue package.

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