Global inflation is largely under control, and the major central banks have started their rate-cutting cycles. This includes the US Federal Reserve, which reduced rates by 50 basis points in September. While economies are cooling, we don’t expect widespread recessions. Fixed income yields are relatively high compared to the past few years, offering an attractive entry point into the asset class. We therefore expect positive total returns, driven by the tailwind of falling rates and lower yields.
What are current market conditions and risks?
Market conditions reflect the belief that the US economy can achieve a ‘soft landing’. Robust corporate profitability has been one of the factors compressing credit spreads across investment grade (IG) and high yield (HY), which have tightened below their respective long-term averages. Corporate fundamentals remain resilient, with leverage and interest coverage ratios at comfortable levels, indicating investors are being adequately compensated for taking on credit risk. This view is also supported by credit agencies, which are forecasting a relatively benign default environment. However, we are more cautious on the lower-rated HY bonds and are very selective regarding exposure to these names.
The main risks to the current environment are deteriorating economic growth, which could impact corporate profits, and a resurgence of inflation that might compel central banks to halt rate cuts. Neither scenario is our main prediction.
How might investors access the fixed income story?
The focus on outcome-oriented strategies is driving interest and asset growth. Achieving a compelling yield in a risk-controlled manner is an attractive outcome for many bond investors, especially as the return on cash deposits begins to fall. This includes our short-dated enhanced income strategy, which aims to generate excess returns relative to cash while providing significant liquidity.
In this strategy, we concentrate on high-quality, short-term bonds, commercial paper, and other fixed income instruments with maturities typically under one year. Our goal is to minimise interest-rate and credit risks to ensure a stable return profile, particularly regarding potential drawdown risks. Additionally, this strategy offers potential diversification within a fixed income portfolio, with more effective balancing of risk and return.
Sweet spots in the bond universe
The first step to achieving specific outcomes is identifying bonds that provide reliable income and resilience across various market conditions.
Long-term analysis of credit markets shows that combining BBB (the lowest IG rating) and BB (the highest HY rating) bonds consistently offers the best risk-adjusted outcomes. This is the focus of our global income bond strategy. Investors who concentrate on strategies managed against traditional credit benchmarks often overlook and underappreciate this section of the market. Structurally, the strategy has provided unique benefits, such as high yield-like returns, with investment grade-type risk.
When combined with disciplined bottom-up credit research, global income bonds can be an attractive option for delivering client outcomes.
Investing in climate, investing for the future
Sustainable bonds, particularly those focusing on climate transition, present a forward-looking investment opportunity. Many climate-related products concentrate on portfolio appearance, such as emission targets or ‘green’ bond labels. In contrast, our approach prioritises real-world decarbonisation and adaptation. By identifying major emission sources across sectors like energy, transport, materials, real estate, and industrials, we target companies with robust, credible plans for emission reductions.
Our climate transition bond strategy aims to capitalise on multi-decade climate initiatives, offering attractive returns with a focus on a tangible environmental impact.
Final thoughts…
There’s currently US$6 to 7 trillion sitting on the sidelines of the investment world. We believe fixed income offers a compelling destination for much of this capital. Interest rates are heading lower, which will be supportive of bond returns. Although economies are slowing, we anticipate a ‘soft landing’, particularly in the US. Lastly, while we don’t expect large-scale defaults, careful selection to avoid underperforming assets will remain crucial.
You can find out more about our fixed income strategies by visiting your local fund pages