IN PARTNERSHIP WITH
For more information visit: www.incisiveworks.com
This digital experience is an Incisive Works product © 2023 Incisive Business Media (IP) Limited
ixed income markets have gone through a painful transition, but the outlook is now a lot more positive. Volatility and risk are far from off the table,
F
scroll
FIXED INCOME
Relocating the fixed income opportunity — the case for going global
Blue bonds: long-awaited innovation or yet to make a splash?
Bonds are back, although risks persist
Opportunities and risks in an improved environment for fixed income
Fertile ground
FOR PROFESSIONAL INVESTORS ONLY
Spotlight on: fixed income at Capital Group
With that in mind, this guide takes a look at the some of the key themes in fixed income today.
“Volatility and risk are far from off the table, but higher yields have made safer, investment grade opportunities much more attractive”
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only. For professional, institutional and accredited investors only. Capital at risk. The views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. While any third-party data used is considered reliable, its accuracy is not guaranteed. This commentary is provided for informational purposes only and should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer to sell or the solicitation of an offer to purchase shares or other securities. Holdings vary and there is no guarantee that a portfolio has held or will continue hold any of the securities listed. Wellington assumes no duty to update any information in this material in the event that such information changes. In the UK, issued Wellington Management International Limited (WMIL), a firm authorised and regulated by the Financial Conduct Authority (Reference number: 208573). In Europe (ex. UK and Switzerland), issued by Wellington Management Europe GmbH which is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin). ©2023 Wellington Management. All rights reserved. As of 01 January 2023.
but higher yields have in our opinion made safer, investment grade opportunities much more attractive, while high yield and emerging market bonds are offering greater recompense for their associated risks.
First, Investment Specialist Marco Giordano outlines the risks that remain in the market, before summarising three key areas of opportunity. Then, Fixed Income Portfolio Manager Campe Goodman and Investment Specialist Will Prentis, discuss the potential for the blue bond market to grow in size and quality just as the green bond market has.
Finally, Marco discusses why the new environment for fixed income may be making a global approach to fixed income more valuable.
For professional investors only
or BROWSe OTHER CHAPTERS
READ THE FIRST ARTICLE >
SPOTLIGHT
MENU
HIDE X
ixed income is looking attractive once again, but risks, as well as opportunities, abound. Here’s what’s keeping us up at night – as well as where we see opportunities for fixed income investors.
A number of sectors are offering opportunities despite a landscape peppered with risk, says Investment Specialist Marco Giordano
While tensions may have stabilised slightly, US-China relations continue to deteriorate and the structural trajectory of the relationship remains clearly negative. Meanwhile, the war in Ukraine continues, providing further scope for renewed volatility.
Geopolitical instability
At the end of April, Bank of Japan (BoJ) Governor Ueda kept yield curve control unchanged and announced a comprehensive review of the BoJ’s monetary policy, to be completed in the second half of 2024. These announcements were taken as a dovish tilt by the market, causing the Japanese Yen to depreciate and Japanese Government Bonds (JGBs) to rally.
A shift in Bank of Japan policy
The spread between German and Italian 10-year yields has long been a gauge of the market’s confidence in the financial stability of Italy specifically, and of the euro area periphery more broadly. There were fears this spread would widen materially following the election of Prime Minister Giorgia Meloni in September, but in fact the spread has fallen substantially since then and remained rangebound so far this year.
A puzzling picture for Italian spreads
It’s a puzzling outcome, given Italy’s cash deficit has worsened and budget projections point to a further deterioration of public finances.
Marco Giordano Investment Specialist
A number of countries adopted accommodative policies for years in the wake of the financial crisis, even though their domestic cycle didn’t necessarily require such actions. This led to strong growth in leverage, household debt levels and financial asset prices.
Could policymakers be overtightening?
As inflation remains globally elevated, policymakers in countries such as Sweden, Norway, Australia, New Zealand and Canada run the risk of overtightening, given the increased sensitivity of households to rate rises.
However, we believe what is happening in the Japanese economy should call for a more nuanced approach to interpreting what might come next: for example, Tokyo Core CPI has been at levels not seen since early 1980s, and nominal retail sales are growing faster than in the US. JGBs have long been the anchor for the global rates complex – if and when the BoJ shifts policy, this will likely have reverberations all over the world.
One explanation for spreads staying pinned is huge flows into Italian government bonds (BTPs) from Italian savers; approximately €70bn has been invested by households in Italian government bonds over the last six months, taking up nearly all net new issuance. As the ECB steps out of the market, the Italian saver seemingly steps in. This could potentially have an impact on bank deposits and, ultimately, could hinder the ECB’s efforts to tighten.
Find out more about Wellington's approach to fixed income
“If and when the Bank of Japan shifts policy, this will likely have reverberations all over the world”
Where we see opportunities
As an active manager, our view is dynamic, but we see the potential for pockets of opportunity within the following sectors:
PREV
NEXT
03 / 03
We believe that high yield and EM both remain attractive from an outright yield-to-worst perspective, but we expect continued volatility amid tightening financial conditions (along with geopolitical risk).
02 / 03
We believe investment grade corporate credit provides attractive valuations for issuers that have a low probability of default, despite heightened volatility. Rising geopolitical risk makes higher quality fixed income attractive from a recessionary and capital protection perspective. While inflation surprises still exist, a large portion of the move in global rates has likely already occurred, providing substantial cushion and carry.
01 / 03
We continue to believe that this is the environment for global sovereign and currency strategies to continue to shine, from a total return perspective, a risk diversifiers approach, as well as from a safety and soundness perspective.
1.
2.
3.
Blue bonds - a long-awaited innovation?
NEXT ARTICLE >
< PREVIOUS ARTICLE
The case for a global fixed income approach
Blue bonds could play a critical role in protecting marine biodiversity
interested in blue bonds, which aim to support projects related to ocean protection and conservation.
onds that finance specific sustainability-focused projects or activities – also known as use-of-proceeds bonds – are on the rise. Green bonds remain the most popular form of use-of-proceeds bond, but investors are increasingly
B
One area where we remain cautious: the debt-for-nature swap. This type of structured deal typically involves a creditor providing a government with debt relief in return for a commitment to use some of the debt savings to finance ocean conservation. Because the structure is complex, however, it’s typically expensive to implement. In many cases, the benefit for the blue economy appears to us to be small relative to the size of the transaction.
As we look forward, we see reason for hope. As blue bond structures become simpler and more standardised, investors like us should find it easier to measure and report on the impact that our investments are having.
We met with Wellington's Campe Goodman, Fixed Income Portfolio Manager and Will Prentis, Investment Specialist, to examine the opportunity.
0.8
1.2
2.2
1.8
2.5
4.0
5.5
4.2
4.8
Will: While green bonds traditionally finance projects related to broad environmental objectives, blue bonds raise capital for projects specifically supporting the blue economy: the sustainable use of ocean resources for economic growth, improved livelihoods and jobs while preserving the health of the ocean ecosystem.
We've heard of green bonds, but what is a blue bond?
Will: Our oceans and seas play a crucial role in the world's economy, driving sectors such as fishing, transport, tourism and renewable energy, and providing both natural resources and employment. Data from the UN Global Compact estimates that the blue economy represents around 2.5% of global GDP - comparable to a country in its own right.
Why is the blue economy so important for investors?
Blue bonds can be issued by sovereigns, development banks, corporates or other organisations. For investors, blue bonds offer a way to potentially earn a financial return while also supporting sustainable development and environmental conservation.
For the productive use of our oceans to continue, the health of the ocean ecosystem must be preserved. Yet SDG 14: Life Below Water, receives the lowest long-term funding of any of the UN Sustainable Development Goals. There is a critical funding gap for an environmental challenge that disproportionately affects the world’s poorest.
For each bond we analyse, we determine the fit with the three key tenets of our impact philosophy: materiality, additionality, and measurability. We ask: to what extent are the bond’s proceeds aligned with our impact themes? Is financing directed towards ongoing or future projects? Are the projects going above and beyond the ordinary course of business? Can we measure and track key performance indicators of impact?
Campe: There’s a real need for investment in the blue economy. However, we’ve seen time and again that innovations in sustainable investing need time to mature. A label – even from a well-known sustainability rating company – doesn’t guarantee impact.
What do investors need to know before investing?
Label or not, we continue to advocate a bottom-up, research-driven approach to impact investing. We believe in taking a thoughtful, independent approach to each investment opportunity, and in putting capital to work to meet both impact and financial objectives.
Campe: Growth and innovation in blue bonds is a prime example of how the supply of impact investments is increasing in the public fixed income markets. We believe today’s green bond market is larger and higher quality than the green bond market of five years ago, and we’re optimistic that blue bonds will follow a similar arc.
How would you summarise the opportunity within blue bonds?
Will Prentis, Investment Specialist
Campe Goodman, Fixed Income Portfolio Manager
“We continue to advocate a bottom-up, research-driven approach to impact investing”
“There is a critical funding gap for an environmental challenge that disproportionately affects the world’s poorest”
FIND OUT MORE ABOUT WELLINGTON'S SUSTAINABLE FIXED INCOME CAPABILITIES
Relocating the fixed income opportunity – the case for going global
Geographical diversification looks ever more valuable given shorter cycles and rising rates in Europe, according to Marco Giordano, Investment Specialist
2
Central banks are at different stages of the cycle. The US may potentially face a meaningful tightening in credit conditions, potentially prompting the Federal Reserve (Fed) to end its hiking cycle. In Europe, the European Central Bank (ECB) is starting to reduce its balance sheet, following a decade of significant purchases. The reversal of that support, along with further monetary policy tightening, could represent a significant headwind for European rates.
This new macroeconomic regime will likely present shorter and more pronounced cycles and a greater occurrence of idiosyncratic risk – whether from country, sector or individual issuer. Geographical diversification may be an important consideration.
fter a painful transition away from the lower-for-longer environment, fixed income appears to have regained its footing. Bonds look attractive from both a diversification and income perspective, with yields at multiyear highs across all
A
sectors. So far, so good, but the recent US regional bank crisis is the latest in a series of events that remind us that bond investors face a new, more volatile normal.
Actively pursuing global fixed income opportunities may be particularly attractive for European investors. Rates across Europe appear to have upward momentum relative to the US, while hedging costs may become materially lower.
Until recently, yields in European core fixed income seemed to be on a permanent downward path, but European sovereign yields have now returned to relatively attractive levels. Conversely, global allocations have been punished by the strength of the US dollar.
Four reasons why going global could pay off
However, looking ahead, we think that diversifying domestic or regional exposures may be more rewarding for European bondholders. In our view, the new regime creates four compelling reasons for fixed income investors to seek global diversification.
The outlook for inflation remains muddier than in previous recessions. In this environment, home biases may be overly reliant on past assumptions; for example, over the past decade the euro area has been a source of disinflation for the world. This appears to be reversing, with headline and core inflation now consistently above the G7 average.
We see elevated levels of volatility and continued event risk on the horizon, such as the potential for further difficulties in pockets of the banking system, the continuing war in Ukraine and multiplying instances of social and political instability as populations across the world face a growing cost-of-living crisis. Pivots in central bank policy may generate opportunities but also risks: most notably the Bank of Japan’s (BOJ’s) imminent exit from its long-standing policy of yield curve control.
These events are all trigger points for renewed volatility, which active diversification across different regions may help mitigate.
As the ECB catches up to the Fed in its monetary tightening cycle, a reduction or tightening in US-Europe short-term rate differentials should contribute to lower hedging costs for Europe-based investors investing in global fixed income markets. European fundamentals remain fairly resilient, in our view supporting continued outperformance of the euro and most other European currencies versus the greenback, facilitating lower hedging costs as a result.
Managing global exposure effectively requires a deep understanding of global and local markets as well as macro and geopolitical expertise. An active approach may be particularly relevant for European investors, as they navigate a very different policy environment with significant divergence between countries and sectors.
How to manage a global exposure
EURO AREA INFLATION NOW SURPASSES THE G7 AVERAGE
Source: Refinitiv, April 2023.
Headline inflation euro area vs G7 average (%)
Difference between average headline inflation in euro area and in G7 over different periods
“An active approach may be particularly relevant for European investors, as they navigate significant divergence between countries and sectors”
Marco Giordano, Investment Specialist
1. Access opportunities across an inconsistent global policy landscape
2. Position for less predictable inflation ahead
3. Take advantage of opportunities to navigate volatility and event risk
4. Benefit from lower hedging costs
FIND OUT MORE ABOUT WELLINGTON'S FIXED INCOME CAPABILITIES
