Michael Krautzberger, BlackRocks head of European fixed income
In the new world of low interest rates, investors dependent on regular income from bonds have three options. First of all, they can simply put up with lower returns. For many, however, this does not offer a solution, because they need to achieve a certain level of income.
"Alternatively, they can increase the amount they invest to ensure a constant return in absolute terms despite the lower rates. Yet many investors lack the financial resources to do so. A third way is to accept greater risk exposure in order to generate a higher potential return.
The latter approach prompts us to ask whether current monetary policy may be encouraging investors to pursue inappropriate risk strategies in their search for higher yields. The question is a pertinent one, since a trend of this nature could lead to asset price bubbles on the capital markets.
BlackRocks model portfolios, based on the US market, illustrate the risks currently facing bond investors: A regular annual return of two percent a year can only be achieved by accepting a risk equivalent to a loss of four percent of the capital invested. To achieve a return of five percent, investors would need to accept roughly half the level of risk attached to the US equities market in 2012 (based on the S&P 500).
These figures demonstrate that the risks for investors who want to protect their money against inflation by assuming a higher level of risk are nevertheless manageable. Equally, when dealing with this new investment context, it is important to bear in mind that cash deposits are also subject to a completely different set of risks than was the case in the past. In many cases, the interest earned on cash deposits does not even make up for inflation.
"It seems entirely reasonable, therefore, for investors to seek out alternatives.
We remain of the view that investor portfolios should be underweight in conventional government bonds and high-quality corporate bonds. By contrast, market segments with a higher credit risk profile offer investors a decent yield from an opportunity/risk perspective, and we would tend to go overweight in these.
"At present, we see no indication that investors are adopting more extreme risk strategies.