A brighter start with some bumps along the way

Navigating fixed interest portfolios in 2025

As we look forward to 2025, the outlook for financial markets is positive, influenced by government policies that are anticipated to stimulate economic growth and revive investor enthusiasm. In our view, for fixed interest as an asset class, the return opportunities for investors remain positive for the year ahead. An active approach will likely be better placed to fully extract these opportunities and at the same time manage reasonable risks.

The financial landscape is expected to be shaped by a variety of factors, including falling interest rates and cash rate expectations, bond yields with less upside risks, credit risks driven by fundamentals and geopolitical dynamics. Despite the complexities, and the volatility that may ensue, we believe these risks are manageable if sized appropriately in portfolios and provide the opportunity for attractive returns through active management.

Our optimism stems from an assessment of where we are currently in the economic and business cycle, marginal policy direction (becoming more accommodative), underlying robust fundamentals and supportive technical factors including liquidity conditions. Whilst global economies were late cycle with restrictive monetary policy, they have weathered this well. In spite of the recent economic environment being much slower growing than during the pandemic policy-boosted era, labour markets remain resilient and corporate defaults are at only moderate levels.

We have witnessed a noticeable slowdown only within particular areas such as highly leveraged sectors, consumer discretionary, property development and small to medium enterprises. The results have been uneven across economies, with the US faring materially better than regions such as Europe and China, and with elevated defaults occurring in specific regions and sectors, whilst others have thrived and still exhibiting historically low defaults. We believe this is partly due to the healthy starting position for this recent managed downturn driven by highly targeted policy – namely consumers with built up savings during the pandemic, elevated levels of corporate profitability (especially relative to pre-pandemic levels), terming out of debt maturities and overall demand being better than anticipated.

The road ahead

As we turn to 2025, the marginal monetary and fiscal policy is becoming more supportive and the recent supply chain induced inflation is moderating. We assess this as a new ‘early stage’ pro-growth environment. While we still expect uneven growth across regions and industries, in our assessment the year ahead represents a positive one for fixed interest investors in both the rates and credit context. As always, risks remain that investors need to keep an eye on and navigate in an active manner, including:

• Winners and losers: The ability of policy to drive confidence and consumption, business investment based on emotions, otherwise known as the ‘unleashing of the animal spirits’, is much greater in some countries and industries than others. As an example, the US and its technologically-driven productivity enhancements aiding growth as opposed to the debt-laden fixed asset investment transition underway in China.
• Shifting global trade alignment: The importance of supply chains, philosophically aligned global trade, tariffs and the protection of key industries are all likely to play a role in supporting growth for some at the expense of others, as has been the case over the past four decades.
• Geopolitics at the fore: The peace dividend has been all but exhausted with a need for greater defence spending not seen in decades. We may well see markets and pure fundamentals play second fiddle to greater nationalistic motives. Investors will need to ‘swim with the tide’ to participate profitably, despite these currents being strong.
• Higher cost of money capital for all: Despite the easing cycle globally underway, the resulting cash rates and bond yields are unlikely to go down to anywhere near those witnessed through the pandemic. The cost of capital, as well as its availability, has changed for the better from an allocation perspective. This will continue to challenge certain over-levered industries as the recent past restrictive policy continues to work through economies. Monetary policy has long and variable lags having an adverse impact even after central banks progress their current easing cycle. Perhaps not as well assessed is the leverage governments carry, especially when fiscally challenged, even including the US and their privileged treasury bond market. It is not without risk that markets challenge this privilege with spikes in risk premia, as key buyers of treasuries look for alternatives.

Positioning opportunities

Whilst the already known and other left field risks need to be managed, as investors it is imperative that we remain focused on the opportunities in front of us. The acceptance of some volatility, coupled with a strong investment plan or blue print will assist in navigating any adverse scenarios and yield the best overall outcomes for investors.

Looking ahead, we see the environment as highly conducive for active and deliberate portfolio positioning in:

• Duration and yield curve selection, currently preferring an overweight stance in short to mid-term maturities most sensitive to the near term cash rate cycle.
• Breakeven inflation, looking for opportunities where short term factors incorrectly drive long term pricing of expected inflation.
• Sector allocation and selection, currently pursuing unfavoured areas such as semi-government bonds, senior debt of A-REITs, university debt, utilities and infrastructure that are necessary for the energy transition but have been caught up in the ESG crossfire.
• Higher yielding sectors, albeit defensively positioned for now, recognising the elevated defaults in certain pockets with minimal compensation, but remaining selective in certain areas such as loans where re-pricing has occurred.
• Tail risk hedging with credit protection, currently quite cheap compared to physical bonds and provides a cost efficient way to enjoy long physical credit exposures with good total expected returns from move, roll and carry (MoRoCa) whilst offsetting to varying degrees the risk of adverse outcomes.

With the above economic, market and valuation dynamic, a proactive and constructive stance to portfolio allocation we feel will serve fixed interest investors best, incorporating attractive levels of yield, some opportunity for capital gains and an element of cost efficient portfolio protection. Whilst not immediately obvious, 2025, in our assessment, is the beginning of a new growth story, driven by animal spirits rather than the end of the last that relied upon policy support.

Managed Fund

Janus Henderson Australian Fixed Interest Fund

Australian Fixed Income

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