By Felipe Villaroel
What a fixed-income manager is looking for is an environment of low but positive growth, contained inflation, banks that do not take on too much risk, and under-represented technology and higher-risk sectors. The reason is simple: they receive the same coupon and recover the same principal regardless of how much a company grows. They do not share in the extraordinary gains that might result from taking on more risk. That is why they are not interested in dynamism, but in stability.
Europe meets these conditions better than the United States. And that is exactly the opposite of what the equity investor is looking for, as they do want growth, companies that take risks and dynamic markets. Everything that weighs down the European stock market compared to the US market — lower growth, more regulation, less dynamism, underdeveloped technology sectors — is precisely what makes its debt an attractive asset. They are two sides of the same coin.
The figures confirm this. If one looks at cumulative returns over different time horizons — ten years, seven, five, three — across different fixed-income asset classes — investment grade, high yield, financials — and hedges for currency, most of the time the indices in pounds and euros outperform those in dollars. What makes the S&P more attractive than European stock market indices is, at heart, the same thing that makes European fixed income more attractive than its US counterpart. A paradox that coupon-focused investors know well, but which is rarely articulated so clearly.
