JEDDAH: High yield and emerging market bonds continue to offer greater income potential and some sensitivity to improving corporate creditworthiness, Barclays Wealth's February Compass issue said. Aaron S. Gurwitz, its Chief Investment Officer, said that "a portfolio of well-selected, well-diversified investment risks is likely to be rewarded by better-than-average risk-adjusted returns." In recent months, the odds have been tilting in favor of the developed high-yield segment, as some emerging market currencies and bond markets have been running out of tactical headroom. Global growth prospects and sentiment have improved in the past month. Perhaps the most significant shift has been in the US, although the EU looks a little brighter too. But inflation has moved center-stage in the UK, and is also the dominant concern in emerging Asia. There is also slightly more upbeat sentiment on the euro area. A symptom of this is that government debt auctions in Portugal, Spain and Italy have met with strong demand - reassuring policymakers that financial markets appear to be more confident that the euro area could survive in its current form. But this carries risks too, the report added. It noted that disproportionately large share of many private investors' assets remain in extremely low-yielding cash and short-term bonds. But "holding too much cash for too long incurs an opportunity cost, which can jeopardize the chances of meeting one's long-term financial goals," Gurwitz pointed out. The default rates for speculative grade credit in 2011 will likely be within spitting distance of their long-term averages – just two short years after the "credit crunch" to end all such crunches. "Despite the high-profile and systemic failures in the banking sector, speculative grade default rates didn't rise as high as feared, and have subsided remarkably quickly," the report further said. Moreover, emerging market equities also remain attractive relative to most other asset classes. However, we do feel that the story is looking stale, and expect developed markets to do better. Valuations are fuller, and interest rate risk more pressing, in the emerging world. Even though commodity prices overall have fallen slightly back in recent weeks, after their strong gains in 2010, they still look expensive to us and much less appealing than equities. Besides, commodities have often performed well after a period of accommodative monetary policy, and the fact that the backwardation of agricultural prices has once again produced a favorable "roll yield". Much of the likely demand from China in particular has long been well-known, is likely already priced-in, and may be stockpiled against. In the energy market, OPEC has plenty of spare capacity, while agricultural supply by definition is relatively elastic – suggesting that a favorable roll-yield historically has not guaranteed positive total returns, it added.
