The return of inflation, an energy crisis, war. The road for investors has been paved with plenty of challenges over the past 18 months. According to the 8,550 people in 23 countries surveyed by the 2023 Natixis Investment Managers Individual Investors Survey1, the top investment concerns were:
- Inflation (58%)
- Recession (38%)
- Market Volatility (28%)
- Rates (28%)
- War (27%)
We are still benefitting from historically high yields in credit. It’s something we had not seen for 15 years.
We have excluded the scenario of recession since Q4 2022 when 80% of economists and strategists were in the opposite direction. Despite the collapse of US regional banks and the volatility that brought to markets, Ostrum AM fixed income strategies have been able to perform.
We may face an economic slowdown in the US and in Europe but it won’t be a hard landing. In my view, recession risk has been exaggerated by some strategists, economists and portfolio managers.
However, rates volatility is very high compared to equity volatility. It should normalize. Low volatility in equity markets and high level of profit margins have been a support for the bull market in equities since the beginning of the year. Firms have been able to transmit the rise of production cost to the final consumer price.
Over the past two years, we have been very active in monitoring and changing the rate duration of our credit portfolios because it has been a source of performance, accounting for 30% of our alpha generation last year. When central banks are hiking rates, you have considerably more volatility in rates compared to the last 20 years. This is something you need to be careful of because rates volatility is a risk for bond portfolios.
Two years ago, we saw negative yields – or certainly close to zero yields. The Investment Grade Index was not at 4.5% but at 0.5%. One third of the Investment Grade Index was posting negative yields, which are not very appealing for most investors.
This period is now over. Fixed income is back. Some asset allocators are reconsidering the asset class and have switched to it from equities. Last February, for the first time in the past decade, equity dividend yield was below the Investment Grade yield.
There’s no getting away from the fact that understanding bonds is demanding. You need to understand, for instance, what a yield, an income, a duration, or a carried interest is. People tend to mix up total return and yield, which are different things. Likewise, there’s confusion around maturity and holding period.
To simplify, if you are after a regular income with fewer risks than equities, you should consider fixed income. If you can invest on your own in equities, it seems more complicated for an individual to invest on their own in bonds.
In our opinion, the simplest way to get access to the fixed income asset class is to invest in mutual funds managed by professionals. A solution might be to invest in hold-to-maturity strategies with a specific maturity date and a given yield.
- Bond – the ‘bond market’ broadly describes a marketplace where investors buy debt securities that are brought to the market, or ‘issued’, by either governmental entities or corporations. National governments typically ‘issue’ bonds to raise capital to pay down debts or fund infrastructural improvements. Companies ‘issue’ bonds to raise the capital needed to maintain operations, grow their product lines, or open new locations.
- Duration – A measure of a bond’s sensitivity to changes in interest rates. Monitoring it can effectively allow investors to manage interest rate risk in their portfolios.
- Fixed income – An asset class that pays out a set level of cash flows to investors, typically in the form of fixed interest or dividends, until the investment’s maturity date – the agreed-upon date on which the investment ends, often triggering the bond’s repayment or renewal. At maturity, investors are repaid the principal amount they had invested in addition to the interest they have received. Typical fixed income investments include government bonds, corporate bonds and, increasingly in recent years, green bonds. Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
- Volatility – Volatility is the rate at which the price of a particular asset increases or decreases over a particular period. Higher stock price volatility often means higher risk.
- Yield – A measure of the income return earned on an investment. In the case of a share, the yield is the annual dividend payment expressed as a percentage of the market price of the share. For bonds, the yield is the annual interest as a percentage of the current market price.
This material is provided for informational purposes only and should not be construed as investment advice. Views expressed in this article as of the date indicated are subject to change and there can be no assurance that developments will transpire as may be forecasted in this article. All investing involves risk, including the risk of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.