Hate to say we told you so… Staying ahead with alpha opportunities

In our last quarterly publication, we highlighted the limited potential for short-term beta returns from Fixed Income, and we emphasized the significant alpha opportunities that we anticipated. The events of the past quarter could not have validated that prediction more accurately.

We now find ourselves reflecting on one of the most volatile and unpredictable periods in recent financial markets history. Clearly, the primary driver of this volatility was the sanctions regime implemented by the Trump administration following “Liberation Day.” That was set against a backdrop of stretched valuations, shifting macroeconomics, a gradual rebalancing of global financial and military power, and the lingering aftershocks of the inflation surge that flowed through developed market economies in 2022. Together, these factors created fertile ground for heightened turbulence.

Given our focus last quarter on the value of alpha, I sincerely hope many of you incorporated that insight into your portfolio positioning. At the Fixed Income Boutique, we have benefitted significantly from maintaining this view. Year-to-date, our flagship, highly active portfolios have delivered incredibly strong risk-adjusted returns, even though markets have, in fact, returned to the same levels they were at during our previous quarterly publication.

Sector overview

Rates Outlook

Sound fundamentals despite erratic trade policies

Similar to the US Federal Reserve (Fed), we do not yet see the risk of rising inflation as averted. At the same time, we do not expect a recession, even though the rising price levels due to import tariffs represent an additional tax burden on US consumers.

Developed Markets

Banking on Banks?

Overall, large US banks are in good shape, but further improvements seem unlikely. However, bank spreads still trade favorably versus non-financial spreads and therefore justify an allocation to the sector.

We expect strong demand, resilient spreads, and supportive technicals will keep European investment grade well-anchored. With solid fundamentals, steady inflows, and attractive carry, the outlook remains constructive.

We expect the sound fundamentals and robust technicals underpinning the US high yield market will buoy current tight credit spreads and offer reasonable total returns to prudent investors.  

The Swiss bond market reacts to global volatility and trade uncertainty by revisiting negative interest rates. Thus, we like the current roll yield the Swiss curve is offering and we believe in positioning with an overweight in the intermediate buckets.

Emerging Markets

EM debt is well-placed to benefit from the end of US exceptionalism 

US trade policies have created market dislocations and value opportunities for EM hard-currency bonds. The end of US exceptionalism and the likely avoidance of a US recession present a good environment for EM bonds.

EM local-currency bonds have significantly outperformed this year, achieving a total return (in USD) of more than 10% in just over five months. We believe there are compelling reasons to expect a continued decline in the US dollar, which would create favorable conditions for the sustained outperformance of this asset class.