<p><span style="font-size:1.0em;">In a world of rising yields and inflation, what can active fixed income investors expect? Here, our fixed income portfolio managers survey the changing market landscape.</span></p><p> </p><p><a class="link-style-default link-page" href="#!/page/6572d4152f2fc4daf258ae59/1" link-style="Default" data-link-target="New tab" target="_blank" data-link-type="page"><b>Return to Contents</b></a></p>
Adam Whiteley, head of global credit, Insight Investment
For the start of 2024, we expect a continuation of credit market conditions experienced in 2023, namely a general lack of compensation for uncertainty in credit spreads. So, while we believe that recession will be avoided in the US, UK and Eurozone, unfortunately this does not mean the outlook is especially positive.
In 2024 a big focus will be on determining where markets are in the credit cycle, whether economies are expanding or contracting at the same pace and how this will affect different sectors within the fixed income arena. This is crucial for determining when and where the key investment risks lie and, as such, getting this right and the relative value opportunities it brings. This could be the key opportunity in 2024.
Ella Hoxha, head of fixed income, Newton Investment Management
After two years of inflationary havoc and hawkish central banks, things are finally changing and bond yields in some countries are now compensating well in excess of inflation, with good asymmetry to high positive returns. We anticipate that stabilising US rate expectations should allow high-carry holdings of foreign bonds, hedged for currency risk, to play an essential role in diversifying investor portfolio risk and beating cash yields.
Looking further ahead, government bonds are likely to provide the best opportunities for investors initially, while credit is likely to offer the least attractive ones. However, we anticipate that credit will get cheaper over the coming months and could start to present buying opportunities for some investors. Looking ahead, our view is that high cash rates and persistent curve inversion could warrant a strong relative value focus for some investors in both developed and local-currency EM rates, favouring steeper curves, high real and hedged yields, and strong policy credibility.
Market threat
The major threat to bond markets could come from digesting increased supply in an environment where central banks have stepped away from buying bonds and are actively selling in the case of Treasuries. The Bank of Japan and European Central Bank are also less supportive of bond supply going into 2024.
We believe fundamentals and valuations will be important in terms of diversifying the global bond portfolios of some investors and for navigating the initial supply period as markets anticipate a slowdown in growth later in 2024.
Private investors will need to take up more of the oncoming supply, and hence valuations and the shape of the curve will, we believe, be important relative to the kind of buying that was less price-sensitive during the previous period of quantitative easing.
Uli Gerhard is a senior portfolio manager, Cathy Braganza is a portfolio manager and senior credit analyst and Lorraine Specketer is a portfolio manager at Insight Investment.
Overall we believe the outlook for the high yield and shorter ended end of the market is positive. But investors will need to adapt their approach to a market which has fundamentally changed from the immediate aftermath of the global financial crisis.
Importantly, we would argue that from 2012 to 2020, the key factors in the market were driven by interest rate movements and the actions of the central banks. Now it’s different. After the Covid-19 pandemic the market environment changed. We find ourselves in a place where bottom-up credit analysis and cashflow modelling are, in our view, vitally important once again. Looking ahead into 2024 and beyond, we believe the quality of this analysis will separate the fund managers who will succeed in this market and generate strong returns from those who will not.
In terms of threats, we do expect to see some defaults, perhaps in the 3-4% range, though we also believe the overall default level will not be as high as we have seen in the recent past. There are potential problem sectors. Some real estate companies whose debt has fallen from investment grade to high yield do look potentially vulnerable. Yet the stability and strength of the high yield debt market, as a whole, has generally improved in recent years. High yield issuing companies have tended to become much bigger and more stable, while the credit quality of high yield indices has also improved over time.
We do expect to see some defaults, though we also believe the overall default level will not be as high as we have seen in the recent past.
High yield investors face a number of questions in the months ahead. Are we going to see growth in 2024? Are we going to see a recession?
We believe we will see a downturn, though we also predict we are unlikely to face a severe recession.
In the current market we do believe it pays to expect the unexpected. In terms of risk, investors need to be fully aware of what is occurring on the geopolitical front. As we have seen in both Israel and Ukraine, events can escalate quickly. Investors need to be aware of their exposure to potentially problematic markets and assess any exposures they have to riskier jurisdictions quite carefully.
We could see an economic downturn in 2024, though we also predict we are unlikely to face a severe recession.
Insight Investment senior portfolio manager Jeff Burger outlines why he is positive on the outlook for US municipal bonds in 2024.
Insight Investment head of efficient beta Paul Benson considers the prospects for high yield in a 'normalised' interest rate environment.
Bonnie Abdul-Aziz, senior portfolio manager, Insight Investment
As fixed income portfolio managers, we naturally mostly see downsides and tend to zero in on the key risks to our asset class in 2024. We have seen markets repricing the term premium in major government bond markets for the last couple of years. At the top of our mind, we feel that the key risk for the European corporate bond market is further market led pressure on a Euro sovereign’s debt sustainability issues.
This comes at the same time as the European Central Bank (ECB) is engaging actively in quantitative tightening (QT) via a run-off on the Pandemic Emergency Purchase Programme (PEPP) and could cause stresses on European government rates which is a destabilising factor for the Euro corporate bond asset class.
We also worry about the impact of rising interest rates to levels that we have not seen for two decades on consumers as well as highly levered corporates who may not have access to funding due to the current circumstances.
Lastly, let us also not forget the rise in populism in Europe recently and how this trend will influence the 2024 European elections – especially in the context of rising geopolitical tensions.
Fabien Collado, portfolio manager, Insight Investment
Impact bonds can deliver beneficial results across a range of sectors. We believe renewable energy and its roll out will continue to be one of the most important drivers of impact bond growth in the European corporate impact bond space in the year(s) ahead.
Post 2022 and the Russian invasion of Ukraine, increased awareness of the need for energy security and safety in Europe massively ramped up the requirement for renewable energy in the region.
Renewable energy utilities were actually some of the first companies to issue impact debt assets in Europe and this is a fairly well-established market. We believe this entire sector holds significant room for growth.
The ongoing move away from using fossil fuels to generate energy means we will need to continue to strengthen renewable capabilities in Europe. Beyond utilities, European banks also issue a lot of green bonds and they tend to fund renewable projects as well. This is not a new area for investors but it is one where we expect to see continued growth.
There is evidence investors are rethinking their approach to fixed income and credit and we could see a profound market shift in attitudes.
Looking forward, I am optimistic for the wider market because there seems to be more interest developing in the European corporate impact bond sector. We see genuine evidence investors are rethinking their approach to fixed income and credit and believe there will be a profound market shift in attitudes. When interest rates finally stabilise, we think people will come back into the fixed income asset class, creating a more positive environment for impact bond investing in Europe.
In terms of threats, the European property investment market has seen some mixed fortunes in 2022/23, with large parts of the sector performing extremely poorly on the back of rising interest rates.
This sector is highly relevant to impact bond investors as it has seen a tremendous amount of green bond-related issuance in recent years. Overall, while we believe the sector holds significant potential for careful stock selectors, we also believe it merits some degree of investor caution.
Impact investing comes with the risk of ‘greenwashing’. Some issuers can overstate their green credentials. It is therefore crucial for investors to continue to run fundamental impact analysis. Impact bonds bring a tremendous amount of transparency to investors and they need to ensure they are selecting projects with the highest level of positive impact.
Renewable energy utilities were actually some of the first companies to issue impact debt assets in Europe.
Simon Cooke, portfolio manager for emerging market fixed income, Insight Investment
We do believe the current growth environment favours emerging markets (EMs) over developed markets (DMs). However, at a macroeconomic level, much will depend on what happens in DMs in the year ahead and thus we are adopting a cautious outlook in the short term.
While most EMs are seeing relatively strong economic growth, the external influence of economic conditions in DMs, currently grappling with uncertain growth, inflation, and rate environments, could inject some potential uncertainty.
Elsewhere, default risk is always a potential threat. As in other credit markets, we would expect default rates to increase in the year ahead, but without seeing a major spike in defaults outside of well-known trouble zones such as China property, Russia and Ukraine.
The good news for EM corporates is that coming into this higher rate, slower growth environment, their leverage is at its lowest, and the interest cover at its strongest, for a decade.
That said, we would expect some level of defaults among weaker companies which have consistently faced operating or financial problems. It is worth noting that investors in both EMs and DMs now tend to be much less forgiving of companies in difficulty than they were in the past, making stock selection increasingly important.
Investors in both EMs and DMs now tend to be much less forgiving of companies in difficulty than they were in the past.
Looking ahead from a sectoral perspective we see opportunity in specific areas within EM markets, including telecoms infrastructure development and renewables. We see structural opportunities in these areas over the next three to five years as their infrastructure is built out across EMs. Both sub-sectors tend to attract businesses with the potential for structural growth.
With telecoms in particular there is huge growth potential in markets such as East, West and Southern Africa. These are regions where millions of people currently live without access to 4G telecoms coverage.
Elsewhere we are very excited by the innovation we are seeing in impact bond markets across EM. The world’s first tradeable blue bond, biodiversity bond and gender equality bond all came from emerging markets and we expect to see more innovation over the next 12-18 months.