Global Strategic bonds: A global approach to the new bond regime
- 27 May 2024 (3 min read)
As a new normal for government bond yields looks set to emerge, Nick Hayes, portfolio manager for our global strategic bonds strategy, outlines why this new regime is good news for unconstrained global fixed income.
A return to the low-inflation, low central bank interest rate environment of the last decade looks unlikely. Underpinned by peak globalisation, large government bond supply, the energy transition and heightened geopolitical tensions a new era is emerging, where global inflation and government bond yields settle but remain elevated.
Changing risks, new opportunities
This new regime brings new market characteristics that shift the risks and opportunities for bond investors. Being aware of these changes means there is opportunity to enhance returns for global bond portfolios.
Fixed income yields have risen sharply in recent years, and this brings a compelling prospect for both attractive carry and capital gains. Furthermore, a higher-yielding environment gives the asset class a more favourable risk reward profile – the short- and longer-term outlook for fixed income is more attractive than it has been for some time.
The price for higher yields seems to be more volatility across global fixed income markets. We think that the unstable geopolitical backdrop, deglobalisation, shifting rate expectations, slower economic growth and the impact of tighter monetary policy is likely to see volatility continue.
But more volatility means more opportunities to find pockets of value within the global fixed income universe. Investors with a global view – and the necessary resources and expertise – can diversify holdings to insulate portfolios from large swings in local markets.
Diverging central bank policy presents tactical opportunities
While expectations of global rate cuts have been dialled back, we believe that central banks on this side of the Atlantic won’t wait for the Fed to cut first, and several emerging markets have already started cutting rates. This divergence brings opportunities for global bond portfolios, particularly for investors who can tactically manage their duration risk across different government bond curves.
The lag effect of monetary policy is clearly affecting individual issuers and there has been a modest uptick in credit events. Default rates in global speculative-grade– one of the stronger performers of the global fixed income universe – have crept up from below 2.0.% two years ago to over 5.1%. We don’t believe that this indicates increasing systemic risk, but investors need to ensure that allocations to risk assets are backed up by rigorous bottom-up fundamental analysis to avoid being caught by defaults.
Positioning for the new regime
Positive on rates and credit
To make the most of different opportunities on either side of the Atlantic, our strategy is bar-belled across duration risk in Europe and lower quality credit in the US and emerging market debt.
Setting duration levels according to market divergence
We have been selling investment grade credit and using the proceeds to allocate further down the credit curve into US high yield and emerging market debt and to tactically manage our duration exposure, currently 4.8 years (as of 22 May 2024).
In line with our views on market divergence, we have been tactically choosing where to take duration risk, reducing dollar duration, but adding to European and UK curves. Our exposure currently stands at 3.5 years across UK and Europe and 1.3 years in the US.
Taking on risk
In credit, we prefer to take risk further down the credit spectrum. Despite strong spreads and rallies in recent times, all in yields remain attractive and company fundamentals remain strong, combined with healthy demand, should see spreads grind tighter and returns continue their recent positive trend.
Increasing allocation to emerging markets
We’re also more positive on emerging market corporates and sovereigns than we have been for some time. We believe there is an improving trend in some of the key restructuring stories of the last few years – Argentina, Gabon, Egypt and El Salvador are all names we own and are stand out recovery stories in their own right. While emerging market investment grade spreads are tighter than they have been for many years, it has been the compression of lower-rated names that has positively contributed.
Outperforming the global fixed income universe
In terms of the risk buckets that we use to organise our allocation, we have been increasing allocation to the aggressive category (High Yield Credit and Emerging Market Debt) and maintaining a third of our assets within the defensive category (Developed Market Government Bonds). This has been achieved at the expensive of intermediate assets (Investment Grade Credit and Periphery Government), where the proceeds from investment grade credit have been used to buy credit further down the risk spectrum and to tactically manage our duration exposure.
Source: AXA IM as of 30 April 2024. Risk Bucket historic high, low and current allocation. Based on month end positions since inception (19/10/2020)
In this new regime we are seeing some volatility in the performance of individual fixed income asset classes where one month’s performance can quickly be eroded by the next. By maintaining structural diversification across fixed income risk factors, tactically managing where and when to add duration and having conviction in single names means over the past year and year to date periods our strategy has captured the upside when markets have rallied and avoided the worst of the volatility when markets have trended sideways.
Source: AXA IM as of 16 May 2024.
Our recent performance demonstrates the strong momentum building in our strategy, while our longer-term track record highlights the ability to deliver in a variety of market conditions. We are confident that we have the expertise and right investment framework and philosophy to deliver risk adjusted fixed income returns in the new market environment we are facing.
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