December 21, 2010

Outlook 2011, Fixed Income: Low-Rate, but Volatile, Recovery, Neuberger Berman Says

Firm sees bonds losing to equities

The fixed-income market in 2011 should see a continued, modest U.S. economic recovery with low interest rates, but 2010’s generally strong results accompanied by periods of uncertainty suggest more volatility to come in the new year, according to analysts at Neuberger Berman.

“In the credit markets, there has been a lot of drama in the last months,” said Bradley Tank, Neuberger Berman’s chief investment officer of fixed income, at a firm-sponsored roundtable luncheon in New York on Dec. 15. “I don’t think these interesting times are behind us by any stretch of the imagination.”

Overall, the Neuberger Berman fixed-income team's outlook for 2011 foresees that the new year should provide a positive environment for “sensible” risk-taking. This could lead to further outperformance by non-Treasury bonds, according to the firm’s “2011 Outlook: Fixed Income” report distributed during the roundtable talk.

At the luncheon, however, Tank conceded that current market conditions favor stocks over bonds.

“The move from bonds into equities makes sense now,” he said, noting that he expects to see a heavy flow of funds out of high-yield bonds in the fourth quarter of 2010.

Tank said that institutional investors in pension funds will nevertheless be buyers of bonds in higher yields in the new year thanks to pension funds’ investment mandates. High-grade income levels will not be stellar headed into 2011, but “the emergence of value is pretty robust in munis,” he added.

Still, the firm is “really bullish” on investment-grade credit, said Tank’s colleague, investment-grade chief and portfolio manager Andrew Johnson, though he added that it was highly unlikely in 2011 to see the 6% fixed-income returns of 2010. Instead, expect returns of 2% to 4%, Johnson said.

As of Dec. 15, Johnson said a 10-year Treasury at 3.50% makes sense. “Absent an actual rise in inflation, there is no reason to expect rates to rise materially higher,” he said.

Headquartered in New York, 71-year-old Neuberger Berman became independent from former owner Lehman Brothers after the 2008 financial crisis. Neuberger Berman is now a private, employee-controlled asset management firm with $82 billion of fixed-income assets under management as of Sept. 30 in addition to $82 billion of equity AUM and $16 billion of alternatives AUM.

Tank said at the luncheon that the firm’s portfolio construction is neither singularly focused nor top-down, so “there is no such thing as a Neuberger Berman view on anything,” whether in munis or quantitative investment or any other credit in between.

Highlights from Neuberger Berman’s “2011 Outlook: Fixed Income” published report:

Economic Growth. Neuberger Berman’s forecasters believe that the U.S. economy will grow slowly and avoid a double-dip recession, and the Federal Reserve’s new round of quantitative easing, or QE2, is likely to be effective in keeping long-term rates low.

U.S. Investment Grade Fixed Income. Robust risk appetite and investor demand for yield should support investment grade spread sectors in 2011.

U.S. High Yield Bonds. Although yield spreads have narrowed, Neuberger Berman believes that positive economic growth, benign inflation, strong demand and falling default rates may benefit the high yield market.

International Fixed Income/Currency. Certain non-U.S. sovereign issues offer attractive yields while austerity measures may hamper peripheral Europe’s corporate bonds. Divergent monetary policies should continue to affect currency markets.

Emerging Market Debt. Demand for better yields, faster economic growth and investors’ healthy risk appetite favor emerging debt, although recent spread compression poses risks.

Municipal Bonds. With the death of Build America Bonds on Dec. 31, state and local governments could see an increase in municipal bond downgrades and greater volatility, as well as a sharp rise in traditional tax-free bond issuance.

See AdvisorOne's Outlook 2011 calendar to find the publishing dates for, and links to, other categories in the Outlook series.

Read “Outlook 2011, Economy and Markets: LPL Sees Tepid Growth, Range-Bound Stocks” at AdvisorOne.com.

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