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Today, fixed income investors have to operate in a very different environment with profound implications for how fixed income and, in particular, credit portfolios are managed. Here, Fixed Income Investment Director, Paul Skinner and Matt Knight, Head of Distribution for UK & Ireland explain more.
The low-rate, low-yield environment of recent years has given way to a completely new landscape for fixed income. Back in 2020, if you were an investor in government bonds, there was a fairly good chance you’d be receiving a negative yield – essentially paying to buy government debt, while even in better-yielding sectors total returns were challenged. Fast forward to 2023, and bonds benefit from higher rates and, in the case of credit, attractive spread levels.
2022 saw central banks implement an enormous shift in monetary policy to control inflation, and we expect this trend to continue. Looking forward, we think that this new regime of higher inflation, increased volatility and more restrictive monetary policy will remain intact.
This new environment creates real opportunities for long-term fixed income investors particularly in the credit space — provided they can navigate it successfully as, compared to the last decade, this is unfamiliar terrain.
The new macroeconomic regime we are entering into will come with a new set of characteristics, all of which will affect how we look at bonds. Our macro team expects higher and more volatile inflation, greater interest rate volatility, more restrictive monetary policy, increased dispersion, especially within credit, and further periods of positive correlation between bonds and equities. Those are a lot of opportunities – and risks – to navigate.
The rulebook hasn’t been torn up, but in this environment, we think the considerations for successful fixed income investing have been somewhat rewritten.
The coming year is going to be quite interesting for bond markets. We do not expect a deep recession, but we do not believe that central banks have conquered inflation. This means we probably have a longer but shallower recession to come and that bond yields may remain elevated, perhaps for longer than the market assumes. As a result, credit returns may be healthy as corporates deleverage their balance sheets in a slow, but not catastrophic, economic environment. If rate surprises wrongfoot the market, we expect further volatility – bringing with it opportunities for active managers to outperform.
We believe it’s important that investors have access to broad expertise across the fixed income spectrum. As a firm, we have been managing fixed income since 1928 across several cycles, and since then we have built a robust platform of offerings over time, with dedicated investment teams focused on investment grade and high-yield spaces. A common hallmark across all our strategies is the conviction that an active approach underpinned by fundamental research is key to driving the potential for outperformance over time.
We think this approach lends itself particularly well to the current environment. Greater dispersion, increased interest rate volatility, more differentiation between countries – these represent exciting opportunities for active fixed income investors – but deep research and access to a broad range of regional and sector expertise makes outperformance far more likely, in our view. Our fixed income teams operate independently, enabling them to be true to their investment philosophy and process, but they greatly benefit from our collaborative culture to gain the multiple perspectives we think are so essential in this new regime, whether it is insights from their equity peers or analysis from our macro or geopolitical strategists.
Liquidity also remains a critical focus in this more constrained world. We pride ourselves in managing highly liquid portfolios and understand the importance of being able to deliver clients daily liquidity when they need it most.
We think careful consideration of ESG factors is now on a par with fundamental credit analysis in identifying risks and opportunities at both a sector and company level.
ESG factors can have a significant impact on long-term company performance, particularly as the dispersion among investment-grade issuers increases. Growing ESG-related risks in areas such as climate change or supply-chain issues – together with quickly evolving regulations – create further impetus for well-performing companies to progress their sustainability practices. This accelerating momentum has only increased the importance of identifying likely ESG “winners” and “losers”.
We have two really important climate partnerships with two of the world’s leading institutions in their respective areas of climate change: Woodwell, and MIT. For our fixed income investors, taking a long-term view, they need to know how climate is going to change, what the physical and transition risks are and how we can help guide them through a sensible transition. The research partnerships that we have with Woodwell and MIT are key to that scientific analysis.
By Paul Skinner, Fixed Income Investment Director and Matt Knight, Head of UK & Ireland Distribution
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FOR PROFESSIONAL INVESTORS ONLY
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Disclaimer
For professional, institutional and accredited investors only. Capital at risk. The views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. While any third-party data used is considered reliable, its accuracy is not guaranteed. This commentary is provided for informational purposes only and should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell or the solicitation of an offer to purchase shares or other securities. Holdings vary and there is no guarantee that a portfolio has held or will continue hold any of the securities listed. Wellington assumes no duty to update any information in this material in the event that such information changes.
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