‘Regime change’ delivers bond boost

June 2023
 

Seismic shifts in the global macroeconomic landscape and growing investment in climate transition could create major opportunities for active fixed income portfolio managers, says Insight Investment head of global credit Adam Whiteley.

Highlights

• Inflation has risen and interest rate volatility has exploded back into life, according to Whiteley.
• Macroeconomic volatility is expected to remain high and this could potentially create some fresh opportunities for active investors.
• Fixed income investors faced a difficult period last year but seem to be in a much better place today.

Both global markets and our natural environment are in transition, as inflation and higher interest rates return and policymakers and issuers start to join forces in the battle against global warming, according to Insight’s Adam Whiteley.

Evidencing this change, Whiteley notes he has seen global green bonds grow rapidly over recent years, they have overtaken global government, high yield and investment grade credit in percentage growth terms.

Yet today’s uncertain and transitioning market, posits Whiteley, presents a landscape where investors should expect the unexpected. While the rise of both inflation and interest rates presents an obvious challenge for investors, other less obvious pitfalls may lie ahead, he adds. These, in turn, could bring both threats and opportunity for fixed income managers.

“Whether it is inflation crises, wars or banking failures, you name it, we are seeing it. The short-lived UK gilt crisis last year was just one of a number of ‘flash crashes’ we have seen across a range investment markets in recent times. 

“In an environment where we are transitioning from one financial regime to another (in this case, low interest to high interest rates), portfolio managers need to be just as good at risk management as they are at risk taking in order to capitalize on market opportunities. A more global approach may also help investors build diversification and manage credit liquidity,” he says.

Volatility ahead

Reflecting on recent macroeconomic trends and their likely impacts, Whiteley says he expects elevated levels of market volatility to persist in the months ahead.

“We are seeing a huge transitional shift in the macroeconomic environment – in what we regard as a macro ‘regime change.’ According to Whiteley, inflation has risen and interest rate volatility has exploded back into life. Macroeconomic volatility is expected to remain high and this could potentially create some fresh opportunities for active investors,” he says.

While Whiteley expects headline inflation to fall in the months ahead, he believes the core inflation picture is more mixed and will continue to fuel wider market volatility. He expects interest rates will remain high over the short-term. 

“While energy and food prices have fallen, wage pressures remain as high employment levels persists,” he says.

“Although we have seen much tightening from policymakers, central banks only belatedly recognized there was an inflation problem. As fixed income investors watching recent events, it is really puzzling for us that so many market analysts seem to think interest rates are going back down. We just don’t think that is the case,” he adds. 

While market analysts debate the next likely interest rate moves, Whiteley believes fixed income markets have now recovered from a torrid 2022 and are well positioned to deliver some healthy income to investors.

Rising yields 

“Fixed income investors faced a difficult period last year but seem to be in a much better place today. Higher government bond yields are returning, credit spreads have increased in reaction to policy uncertainty and investors are now also getting more compensation for taking on corporate default risk,” he says.

“We believe fixed income is back and able to deliver income and diversification again. Consequently, we are seeing a lot of interest from strategic investors who are reengaging with fixed income as an asset class.” 

Despite swirling market volatility, Whiteley also believes markets may see a slower rise in defaults than many think across credit sectors in the months ahead. But the combination of lower earnings and higher borrowing costs should ultimately catch up with the high yield and leveraged loan markets, he adds.

“The starting point for corporate issuers is pretty good and despite some recent problems in parts of the banking sector, we believe financial regulations have been massively improved since the global financial crisis and remains broadly robust,” he says. 

As financial institutions and other issuers become more engaged with efforts to tackle climate change and wider environmental, social and governance concerns, Whiteley also points to exponential growth in the impact bond market, a trend that looks set to continue.

“Impact bond growth has been rapid with many public and corporate issuers coming to market, with much of this issuance offering social and environmental benefits. Investors may also seek to support activity from issuers aligned to the United Nations’ Sustainable Development Goals. Another approach is for investors to take a proactive role in supporting companies seeking to transition areas of their business to improve their sustainable characteristics by investing in their debt and actively engaging with them,” he concludes.