TwentyFour Asset Management
After what can only be described as a relatively dire year for fixed income in 2022, during which spiralling inflation led to one of the most aggressive rate hiking cycles on record, we believe the market for bonds is now looking much healthier.
Bonds have once again found their mojo, with yields significantly higher across the board and a growing sense that the successive and rapid increases in interest rates enacted by central banks across the globe are now coming to an end.
But it is not a dead cert that central banks have reached their rate hiking peaks, with the US Federal Reserve stating that it will listen to and study the data before considering its next moves.
And in environments like this, when much can change quickly and central bank decisions are coming thick and fast, the need for a ‘go anywhere’ bond strategy that spans government bonds, investment grade, high yield and emerging markets, as well as more specialist sectors such as subordinated financials and asset-backed securities, becomes more imperative.
Calling the next move of the Federal Reserve, the European Central Bank and the Bank of England has become harder to do, with economies globally still grappling with rising prices and the threat of recession. But the central banks have indeed been in action mode.
In September, the US Federal Reserve held rates in the range between 5.25% and 5.50% but this came only after it increased its benchmark rate 11 consecutive times, with the last 25-basis-point rate rise announced in July, while the Fed also continued its hawkish tone and predicted less cuts next year than previously forecast.
Meanwhile, the European Central Bank held rates in October but not before hiking them in September by 25-basis-points to 4%, the highest level in the eurozone’s history, with ECB president Christine Lagarde adding that, although borrowing costs may have reached their peak, they will remain high for as long as it takes to curb inflation.
And, in the UK, the Bank of England increased rates on 14 consecutive occasions before holding them steady at 5.25% in September.
To find the best opportunities in situations like this, where centrals banks are moving swiftly, investors need to be able to act promptly and therefore we believe that a ‘go anywhere’ bond strategy becomes more attractive and necessary.
The job of an active, unconstrained fixed income manager is to adapt a bond portfolio (sometimes very rapidly) as the cycle progresses, shifting allocations to capture different risks as market conditions evolve.
The credit market gives managers plenty of flexibility, because it covers a huge universe of bonds from different issuers and geographies, offering an expansive range of risk characteristics, maturities and ratings.
To maximise risk-adjusted returns across the economic cycle, unconstrained fixed income managers always try to balance three considerations – the amount of credit held, the quality of that credit, and the duration of the credit allocation.
Portfolio managers of ‘go anywhere’ bonds can ensure the assets in the strategy do not work against each other as the market moves and that the fixed income holdings work in tandem.
The need for this has become pertinent as market participants attempt to work out what kind of landing – hard or soft – will be orchestrated by central banks for the global economy.
Looking at the economic data, this time last year global GDP was bouncing around zero and we felt that the outlook was quite negative. It was felt that the aggressive rate hiking cycle that we were seeing would possibly result in a recession in a short space of time. However, that has not been the case and global economies have been much more resilient than we might have expected, with the IMF and the OECD upgrading their outlook for global growth.
Despite an overall weakening in global economies, expectations for a soft-landing in the US and Europe are still very strong. We have had a ‘soft-ish landing’ base case for quite a while now so, while we think that respective economies will flirt with the idea of a recession, we do not believe they will fall into one in a big way.
Even though the economic picture has been much more resilient than we expected last year, there remain pockets that we are still cautious on, such as the chemicals and advertising sectors, and it is our view that having a manager in place to ensure these types of sectors are avoided is key.
No two economic cycles are the same. For example, the new cycle ushered in as a result of spiralling inflation and central bank action has seen spreads move rapididly, whereas normally, as we approach late cycle, spreads are typically very expensive.
Active fixed income managers can adjust the three dimensions of their credit allocation – amount, quality, duration – quickly in response to changing market conditions.
This can be particularly beneficial in the transition between phases. Between mid and late cycle, for example, tilt your allocation toward rates too early and you may miss out on continued credit spread compression; too late and you might incur mark-to-market losses as investors begin to fear the riskier end of credit.
In our view, the current market is moving fast and a go-anywhere approach can help you keep up.
The views expressed represent the opinions of TwentyFour as at 3 October 2023, they may change and may also not be shared by other entities within the Vontobel Group. TwentyFour, its affiliates and the individuals associated therewith may (in various capacities) have positions or deal in securities (or related derivatives) identical or similar to those described herein.
Any projections, forecasts or estimates contained herein are based on a variety of estimates and assumptions. There can be no assurance that estimates or assumptions regarding future financial performance of countries, markets and/or investments will prove accurate, and actual results may differ materially. The inclusion of projections or forecasts should not be regarded as an indication that TwentyFour or Vontobel considers the projections or forecasts to be reliable predictors of future events, and they should not be relied upon as such.