Marketing communication
This page contains marketing information
Marketing communication
This page contains marketing information
Andrew Chorlton, CIO Fixed Income
This inaugural fixed income quarterly letter is not intended to be another quarterly market scorecard. You will already have plenty of those. Instead, I want to share what we are hearing from clients, what we are not hearing, and where that gap may matter for fixed income investors.
The idea is that this might offer some insight into where things are going rather than reminding you where they have been.
Credit: Complacency of confidence
The interest in credit of all flavours continues to be relentless. The demand has persisted through geopolitical volatility and central bank pivots, but most interestingly, it appears largely immune to price. There are a host of ways to evaluate whether or not credit spreads are expensive, but to our mind, there is no doubt: credit is expensive. Nevertheless, there is a real confidence among clients that credit or credit managers will continue to deliver returns. Despite the bulk of that return coming from the risk-free rate, they seem much more comfortable to experience spread widening than any other kind of market risk.
Some of the comfort among credit investors is often justified by highlighting the attendant and well-known risks of investing in government bonds. We hear questions concerning political turmoil, substantial issuance, fiscal challenges, and central bank independence in the face of persistent inflation. Yes, there are plenty of question marks, but they are widely acknowledged. Furthermore, these questions ignore the fiscal and institutional levers available to a government.
Issuance is not only a sovereign story
Meanwhile, corporate bond markets are developing an issuance story of their own, albeit without receiving the same level of scrutiny. This year, the tech sector has issued massive amounts of debt, with expectations that it could reach as high as $1 trillion in 2026, with this only marking the beginning.
Emerging markets debt – now everyone wants to talk about it
12 months ago, we were discussing emerging market debt (EMD), and finding few willing participants. Today, clients are talking proactively about the attractiveness of the asset class. The conversation has been driven by a tailwind of strong performance, improving fundamentals and a diverse opportunity set which still offers compelling investment propositions. The recent convergence of volatility between EM and developed markets (DM) is challenging old assumptions about relative risk, and even the perennial question of the dollar appears to no longer be the barrier it once was.
Duration and the ghost of 2022
That leads me to the elephant in the room…
Is it rational for clients to embrace ‘macro risks’, ie duration and currency, in an emerging market context, yet remain fearful of those same risks in a developed market context?
The only sensible explanation we can come up with is the pain of 2022; that deep bear market for fixed income continues to influence investor thinking today. Yet the market that saw global bond market fall around 15% (and even short-duration markets deliver sharply negative returns) is a very different market from the one we face today. At the beginning of 2022, real yields were deeply negative; today, the starting yield is comfortably positive. Government debt isn’t without risk and certainly not without volatility, but when the real yield for 10-year US TIPS (treasury inflation protected securities) is a healthy 2% plus, we would argue there is sufficient compensation for a lot of those risks.
The lesson of 2022 is that valuation and starting yields matter.
So what?
That does not mean investors should rush blindly into government bonds, nor that credit should be avoided altogether. But it does suggest the fixed income opportunity set is broader than current client conversations sometimes imply. Credit still has a role, EMD deserves the attention it is getting, and developed market duration may be more investable than many investors still assume. The challenge is to avoid fighting the last war, particularly when the battlefield has changed so much.
In the spotlight…
Clare Daly, Portfolio Manager, Fundamental Credit, shares her insight on credit markets today:
It is difficult to argue with the view that credit markets look expensive today and, echoing Andy’s recent observations, yield appears to be the primary driver of investor behaviour.
All-in bond yields remain attractive, but we believe investors need to be selective when it comes to credit risk. While markets have adopted a more nervous tone during September, credit spreads remain compressed when viewed over a longer time horizon. Despite this increased volatility, investor appetite for corporate bonds shows little sign of fading.
Rather than simply reaching further down the credit spectrum in search of income, we believe active managers should focus on identifying opportunities where fundamentals remain underappreciated. In our view, generating attractive levels of income without compromising on our assessment of fundamental risks is exactly the sort of discipline that matters at this stage of the cycle.
At the same time, AI is already beginning to test business models across the investable universe, making deep credit research more important than ever. This is where our strategy can thrive. Working closely with our analyst team, we can engage with the nuances of credit fundamentals, challenge management teams where necessary, and identify opportunities that may be overlooked amid broader market enthusiasm.
The views expressed on this webpage should not be taken as a recommendation, advice or forecast, nor a recommendation to purchase or sell any specific security.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.
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