Sniffing out yield truffles

Investment Themes 2021



Bond yields have been falling steadily for the past 40 years. With low (or negative) rates in developed markets, yield-hungry investors need to move away from traditional government bonds. Below, we explore some avenues.


This theme is aimed at defensive investors seeking yield. It requires a degree of risk-taking to achieve the desired positive and above-inflation returns. However, the risk taken is less than in equity markets. We recommend a minimum investment of 12 months in fixed-income solutions, infrastructure funds and real estate.


Inexorably declining yields

Bond yields have been falling for 40 years. In 2020, yields fell to an all-time low in most developed countries. Indeed, in the eurozone, the average yield on 10-year government bonds is negative, -0.24% as at 8 December, according to the Bloomberg Barclays Index. By comparison, it is 0.94% in the US. Inflation, meanwhile, is historically low but still higher than the aforementioned bond yields. Consequently, an investment in government bonds may yield a negative return, but could potentially result in an even greater loss in real terms. This is likely to persist, as central banks do not intend to tighten monetary policy in the coming quarters or years. This implies that bond yields will remain low for the foreseeable future. Therefore, investors should move away from (risk-free) sovereign debt when seeking yield.

Turning to corporate bonds, the safest are senior credits which have priority in interest and capital payments if an issuer defaults. They offer an average near-zero yield of 0.2% in the Eurozone (at 8 December 2020), forcing investors to turn to subordinated bonds. Although they are a little riskier than their senior counterparts, the risk is ultimately limited if an investor chooses an Investment Grade issuer (i.e. with a solid credit rating). There, the average yield is around 1.8% (as of the same date).

Since March 2020, some 40 European issuers and about 20 American issuers have been downgraded by Standard and Poor’s, a credit rating agency, from Investment Grade to High Yield. These bonds, dubbed 'fallen angels', typically see their credit spread widen sharply before they are relegated to the High Yield category. That occurs only one or two months after their credit spread normalises. So they can offer attractive opportunities. The average yield on fallen angel bonds is 2.7% in the euro area and 4.6% across the pond (at 8 December 2020).

Elsewhere in the fixed-income universe, both hard currency and local currency Emerging Market bonds offer attractive yields of around 4.5% and 4.3% respectively. The risk of this sub-asset class, measured by the annual volatility of performance over the last ten years, is higher than other bond market segments. However, with a volatility of 8.4% for hard currency (US dollar) bonds, and 9.0% for bonds in local currency expressed in euros, the risk is still lower than equity markets (18.4% for the STOXX Europe 600 Index and 16.2% for the S&P500). Emerging Market assets are likely to be a key focus in 2021, as expected dollar weakness should direct financial flows in their direction.

In addition, the infrastructure funds asset class has been growing for ten years. These funds invest in infrastructure in various fields: transport, environment, social, energy, health care, etc. They also offer stable and attractive long-term returns, with the MSCI World Core Infrastructure Index delivering a 3.4% dividend for a historical yield volatility of 14.5%, in other words lower than for equity markets. Some infrastructure funds focus on regular income distribution while others concentrate on capital appreciation.

Finally, real estate is an alternative solution for investors seeking recurring income. Covid-19 has sent structural shockwaves through the sector (e.g. teleworking and e-commerce), but price corrections already largely reflect this. The stubbornly low interest-rate environment has been offering major support for real estate investments. That said, it is important to diversify investments within real estate assets. 


Several risks are associated with this theme:

  • Interest rate risk: when interest rates rise, bonds go down in value. Unlisted assets, in the real estate market for example, are penalised by a rise in real interest rates.
  • Liquidity risk: unlisted assets are, by nature, long-term investments that may be fairly illiquid.
  • Default/restructuring risk: this risk materialises when an issuer cannot repay its debt. Hence, we recommend focusing on high-quality issuers.
2021 Investment Themes

Our 10 Investment Themes for 2021