Fixed Income: Watch out for the tail risk of geopolitics
Conflict in the Middle East. Russia’s war with Ukraine. A trade war between the US and China. Geopolitics shouldn’t necessarily be a source of concern for investors, but in 2024 it has all the potential to translate into market volatility.
According to the latest Natixis Global Fund Selector Outlook Survey,1 while ‘recession’ tops the list of economic threats, fund selectors rank ‘war and terrorism’ a close second. And while 57% believe that the economic impact if the Middle East conflict is contained, 43% are concerned that the effects will continue to reverberate throughout global markets in 2024.
What's the impact of geopolitical risks on the portfolios of fixed income investors? And what about the relationship between geopolitics and inflation?"
“Almost all geopolitical risks would lead to higher inflation,” said François Collet, Deputy CIO Fixed Income at Paris-based DNCA. “Whether it's a trade war between US and China, or an explosion of the Middle East conflict, everything would lead to higher inflation. I think that it's key to try to hedge oneself against it.”
Andrea DiCenso, portfolio manager at Boston-based Loomis Sayles, commented: “China’s ability to influence global growth and reignite global inflation, is something to keep top of mind as we think about our bilateral interactions with them. This influence could disrupt the disinflationary trend that central banks have been working hard [towards].”
Likewise, the potential for tail risks – the probability that the asset performs far below or far above its average past performance – continues to keep fixed income managers awake at night. “Geopolitical risk totally ignores market participants nowadays, but we know that overnight it can change dramatically,” said Philippe Berthelot, CIO Credit and Money Markets at Paris-based Ostrum.
Andrea added: “You don't position your portfolio day in day out for a geopolitical event to occur tomorrow unless you see the volatility rising on the horizon. That is not the case right now.”
Time to get active
Yet, while geopolitical risks are notoriously difficult to forecast, active fixed income managers have plenty of tools in the box to help to try to mitigate the potential impact on portfolios.
“We try to diversify portfolios and find balanced ideas,” said François. “For example, rising global tensions should be favourable for the US dollar, so one way to protect ourselves against an increase in geographical tensions is to be on US dollar.”
Andrea commented: “There is a diversification benefit and an active benefit that you are getting from your active manager who can tilt the portfolio down or higher in quality as that macro backdrop is shifting, as macro volatility is increasing or decreasing and that has been a tailwind to investors' portfolios on the active side.”
Moreover, in a rising inflation environment, after a prolonged period of low or even negative rates, an active manager can take advantage by making ‘carry’ – the gain made from holding a bond after considering the funding cost – a key component of a bond’s performance.
As Philippe put it: “The level of yield we've got on the two sides of the Atlantic is juicy, despite the rally last year in fixed income that still can benefit the all-time high yields on sovereigns or yields on investment grade and high yield in Europe, that haven’t been as high in the past 10 years”.2
As ever in a market environment that remains complex and unpredictable, active expertise is required to uncover every opportunity.
This article is based on the views captured during the Thought Leadership Summit in Paris in March 2024.
Loomis Sayles, DNCA and Ostrum AM are all affiliates of Natixis Investment Managers, and form part of our Expert Collective.
1 Source: Natixis Global Fund Selector Outlook Survey 2024
2 Past market experience is no guarantee of future results
Marketing communication. 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.
According to the latest Natixis Global Fund Selector Outlook Survey,1 while ‘recession’ tops the list of economic threats, fund selectors rank ‘war and terrorism’ a close second. And while 57% believe that the economic impact if the Middle East conflict is contained, 43% are concerned that the effects will continue to reverberate throughout global markets in 2024.
What's the impact of geopolitical risks on the portfolios of fixed income investors? And what about the relationship between geopolitics and inflation?"
“Almost all geopolitical risks would lead to higher inflation,” said François Collet, Deputy CIO Fixed Income at Paris-based DNCA. “Whether it's a trade war between US and China, or an explosion of the Middle East conflict, everything would lead to higher inflation. I think that it's key to try to hedge oneself against it.”
Andrea DiCenso, portfolio manager at Boston-based Loomis Sayles, commented: “China’s ability to influence global growth and reignite global inflation, is something to keep top of mind as we think about our bilateral interactions with them. This influence could disrupt the disinflationary trend that central banks have been working hard [towards].”
Likewise, the potential for tail risks – the probability that the asset performs far below or far above its average past performance – continues to keep fixed income managers awake at night. “Geopolitical risk totally ignores market participants nowadays, but we know that overnight it can change dramatically,” said Philippe Berthelot, CIO Credit and Money Markets at Paris-based Ostrum.
Andrea added: “You don't position your portfolio day in day out for a geopolitical event to occur tomorrow unless you see the volatility rising on the horizon. That is not the case right now.”
Time to get active
Yet, while geopolitical risks are notoriously difficult to forecast, active fixed income managers have plenty of tools in the box to help to try to mitigate the potential impact on portfolios.
“We try to diversify portfolios and find balanced ideas,” said François. “For example, rising global tensions should be favourable for the US dollar, so one way to protect ourselves against an increase in geographical tensions is to be on US dollar.”
Andrea commented: “There is a diversification benefit and an active benefit that you are getting from your active manager who can tilt the portfolio down or higher in quality as that macro backdrop is shifting, as macro volatility is increasing or decreasing and that has been a tailwind to investors' portfolios on the active side.”
Moreover, in a rising inflation environment, after a prolonged period of low or even negative rates, an active manager can take advantage by making ‘carry’ – the gain made from holding a bond after considering the funding cost – a key component of a bond’s performance.
As Philippe put it: “The level of yield we've got on the two sides of the Atlantic is juicy, despite the rally last year in fixed income that still can benefit the all-time high yields on sovereigns or yields on investment grade and high yield in Europe, that haven’t been as high in the past 10 years”.2
As ever in a market environment that remains complex and unpredictable, active expertise is required to uncover every opportunity.
This article is based on the views captured during the Thought Leadership Summit in Paris in March 2024.
Loomis Sayles, DNCA and Ostrum AM are all affiliates of Natixis Investment Managers, and form part of our Expert Collective.
2 Past market experience is no guarantee of future results
Marketing communication. 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.
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