Is there value in fixed income?

At the latest Crestone Investment Forum, held on 22 February 2022, we asked panelists to share their views on the likely path of markets and the global economy in 2022. Key issues focused on the likely persistence of inflation, whether central banks could manage inflation lower without damaging the economic recovery, and when fixed income assets would become attractive.

Our panellists:

• Ben Powell - Chief APAC Strategist, Blackrock
• Steven Watson - Portfolio Manager, Captial Group
• Catherine LeGraw - Asset Allocations Strategist, GMO
• Bill Callanan - Chief Executive Officer, Syzygy Investment Advisory
• Stan Shamu - Senior Portfolio Strategist, Crestone Wealth Management
• Scott Haslem - Chief Investment Officer, Crestone Wealth Management

A rising rate environment can present challenges for fixed income investments. Although rising yields are expected to continue to pressure bond prices, panellists highlighted the importance of exposure to this asset class for liquidity purposes.

Haslem highlighted the challenges around investing in fixed income in a rising rate environment.

“While bonds may look unattractive from a return perspective, there are many positives from a multi-asset perspective, including the importance of liquidity and the ability to make tactical moves.”

Powell feels that ‘defensive’ is an interesting term for fixed income, as it is relates to the price you have to pay. At BlackRock, they are underweight developed market government bonds due to price. From a valuation standpoint, China government bonds yield a higher return in a currency that has been too strong from the authorities’ perspective. Generally, emerging market local currency debt looks interesting, given yields are much higher. 

Powell explained that if you believe US debt is over-priced and needs to moderate, there are opportunities elsewhere. BlackRock would rather play in emerging market local currency debt, given the world is now re-opening and the impetus that Fed repricing would create. Looking further afield, gaining exposure geographically is much more prudent, as some developed market government bonds are generating negative or zero returns in real terms.

Watson agrees and believes the role that bonds play in a diversified portfolio are to act as a form of insurance. While he feels that bonds are an essential part of a diversified portfolio, he does emphasise the need to be more selective with investments. He feels there are some interesting corporates but is biased towards emerging market debt.

“We all know you always pay too much for insurance until you need it, then you didn’t pay enough and you don’t have enough.”

LeGraw explained that, for the first time in its history, GMO does not currently have developed market government bonds in its unconstrained portfolios. Instead, they are finding select pockets of alpha opportunities in emerging markets. While the spreads on offer are not fantastic relative to history, there is the opportunity to generate good alpha. Corporate or state-owned enterprise or quasi-sovereign risk is well priced today so GMO is overweight this segment.

How will credit spreads respond to rate hikes?

LeGraw explained that, within emerging markets, the spread between high yield and investment grade debt is much wider than normal, which can create opportunities. Stressed credit opportunities and structured credit can be interesting on a selective basis, but there is nothing attractive from a traditional fixed income perspective.

Callanan is not too concerned with the impact of rate hikes on credit, particularly given the weighting of energy in high yield indices. Additionally, the weighting of energy in investment grade indices is no longer as high as it used to be. In terms of opportunities, investment grade ex-energy and high yield ex-energy could be very interesting for absolute or relative value trades within the credit spectrum. In emerging markets, state-owned enterprises versus non-state-owned enterprises in mainland China present an opportunity as these debt markets open up and the different bond segments gain critical mass.

The Crestone view:

We expect yields to continue higher, pressuring government bond prices and supporting our current underweight. We believe investment grade and high yield credit will underperform as yields grind higher, so we maintain underweights to those sub-asset classes.