Views from the Collective: Bumps on Fixed Income’s Road Back

“It’s an exciting time to be in the bond markets again – I didn't like working the weekends, but we've ended up in a pretty fun place,” said Elaine Stokes, Executive Vice President, Portfolio Manager & Co-Head of the Full Discretion team at Boston-based asset manager Loomis Sayles.

Elaine was speaking at a fixed income panel during the recent Natixis Thought Leadership Summit in Paris, where she explained how a rapidly evolving investment landscape had improved the attractiveness of fixed income in a portfolio.

“Although the yields of bonds have barely changed in the credit markets, the yield of the reference rate came way down and spreads have widened substantially,” she added. “So, we've repriced to a rate where bonds look attractive, and they look attractive versus all those places that money was going and reaching to find something other than 2%.”

The appeal of fixed income is re-emerging at a time when low rates and low volatility – the status quo since 2008 – have been disrupted. Indeed, our survey¹ revealed fixed income was re-emerging as an asset class of choice for institutional investors. Half of those surveyed claimed 2023 would be the year of the bond, and more – 70% in fact – predicted that a rise in rates would usher in a ‘resurgence’ in fixed income.

Bumpier than expected
In agreement with Elaine was fellow panellist Philippe Berthelot, CIO Credit & Money Markets at Paris-based fixed income specialist Ostrum Asset Management, who pointed to attractive returns that stand out amid the turmoil.

Highlighting rates such as 4% and 7% for European investment grade and European high yield respectively, he said: “Our job is becoming more and more appealing. You have yields we have not witnessed for more than a decade”.

Phillippe warned, however, that fixed income is still not immune to challenges from the wider economic environment and suggested how it will continue to change. “It’s going to be bumpier than expected,” he said. “What is annoying in our perception of risky assets is, on the one hand, we have passed the peak regarding headline inflation. But core CPI, which is without the food and energy metrics, is stickier and going be higher for longer. So, there will definitely be more bumps than expected.”

Stickier for longer
A “bumpier than expected” outlook was shared by the third panellist, François Collet, Deputy CIO at Paris-based DNCA Investments – although he struck a more cautious tone than Elaine and Philippe.

Francois sees volatility continuing to impact bonds in 2023 and questions their diversification benefits, as high inflation has strengthened the correlation between asset classes.

That said, he is optimistic about the supportive stance central bankers are once again taking and sees the chances of another 2008-style global recession as minimal due to the likelihood of further intervention.

“Central banks are too aware of the banking sector problems and they definitely don't want to push the economy to another crash,” said François. “Inflation is going to stay elevated and sticky in the long term. All investors looking for safety should look at the TIPS markets. These are offering very interesting rates and cheap protection against inflation.”

In recent weeks, central banks and supervisory authorities around the world have been forced to intervene even more following the high-profile collapse of Silicon Valley Bank.

Yet this is likely to have limited impacts on fixed income, as Philippe explained: “You have anxiety and stress, but the crisis has been properly managed. Unlike 2008, there is no chaos. We have seen primary market issuance, which means that the market is tough and functioning.”

Volatility knocks
Like many asset classes, fixed income has become increasingly influenced by sustainable investing considerations and the demands of modern investors. This is something all our panellists saw as presenting opportunities for their portfolios.

Greater access to data is an important ‘first step’ when meeting ESG requirements, according to François, but more work needs to be done to build on this progress.

“We are far from the second step, which would be to bring impact investing to the sovereign market, which is obviously much more difficult,” said François. “Engagement policy is much easier in the corporate space than in the sovereign space. You can't exactly complain against a government.”

Though the evolution of ESG still has some way to go, the panel agreed the wider global economy can still present opportunities for fixed income investors. According to Elaine, more volatility is in store as the world continues to change rapidly.

And although this may perturb investors, it can also bring opportunities. As Elaine concluded: “It's when you get the bargains, and when you get to build long-term portfolios. That's what this year is really going to be about – being patient, taking advantage of the volatility, and building a portfolio that's going to work for you in the long term.”

Loomis, Sayles & Co, Ostrum AM and DNCA are all affiliates of Natixis Investment Managers, and form part of our Expert Collective.

GLOSSARY

• 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.
• Reference rate – The reference rate is an interest rate benchmark used to set other interest rates. Various types of transactions use different reference rate benchmarks, but the most common include the Fed Funds Rate, LIBOR, the prime rate, and the rate on benchmark US Treasury securities.
• TIPS – Treasury Inflation-Protected Securities (TIPS) are a type of Treasury bond that is a popular for protecting portfolios from inflation. The principal value of TIPS rises as inflation rises, while the interest payment varies with the adjusted principal value of the bond.
• 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.