Can fixed income markets offer light amid the gloom?

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June 2022
 
While the twin threats of inflation and rising market volatility preoccupy investors, low default rates, strong corporate balance sheets and post Covid-19 resilience could help drive positive fixed income opportunity, says Insight investment specialist April LaRusse.

As fears over Covid-19 give way to geopolitical concern over inflation, rising interest rates and the economic impacts of the Russia/Ukraine conflict, markets face considerable short-term uncertainty.

Yet Insight investment specialist April LaRusse believes current market conditions could present significant opportunity for active fixed income investors able to pinpoint pockets of opportunity.

“While it has been hard to find many positives over the past two years the news is not all bad,” she says. “While investors were right to be worried about the financial impact of the Covid-19 crisis, this proved relatively short-lived. As it turned out the Covid-recession was one of the shortest in history.”

Despite new geopolitical threats arising in Russia/Ukraine, LaRusse says the ensuing volatility may provide some attractive new investment opportunities.

“Volatility can create opportunity. When things are going too well it can be harder to find those dislocations in markets that allow investors to get into opportunity areas at a time when they are relatively inexpensive to gain exposure to,” she adds.

Despite some recent gloomy banking forecasts predicting an economic slump1, LaRusse doubts any major recession is imminent. Instead, she points to a positive corporate response to the pandemic which has seen many companies reduce their debts and strengthen their balance sheets.

Pandemic response

“The shock of the pandemic and its resulting lockdowns made many companies realize they have to minimize the amount of debt they have on their balance sheets and that too much leverage can actually kill some businesses,” she says.

“Even in the high yield sector - where companies tend to carry a lot more debt - we have seen leverage coming down. We have also seen players in this space looking to see if they can issue longer bonds to lock into financing over a greater period of time.”

According to LaRusse, corporate earnings levels currently remain healthy and bond market default risk levels appear low. While supply costs have been rising, she adds, these have been passed on to customers who appear willing to shoulder the greater expense, for now.

At a policy level she has some sympathy for central banks such as the Bank of England, which have f aced political fire over perceived failures in tackling rising inflation.

“Central banks have come in for criticism they were asleep at the wheel while inflation was rising, but you can’t just turn off an economy, turn it back on again and expect everything to work perfectly. The Covid-19 pandemic undoubtedly created its own market distortions and investors now face other challenges such as rising energy prices and geopolitical tensions. The good news is that while financial conditions have tightened, some of the work has already been done in taking the heat out of the economy,” she adds.

Flexible approach

LaRusse believes markets have already priced in much of the factors that could damage economic and financial growth. In terms of market opportunity, she adds that flexible strategies which give investors good credit exposure and lower duration could hold significant opportunity in the months ahead. She also believes there is growing demand for sustainable investments and impact bonds in an environment where investors are becoming increasingly environmentally and socially aware.

“There had been some concern during the pandemic that people might become solely focused on the Covid-19 crisis and lose sight of climate change and other ESG (Environmental, Social and Governance) factors. In fact, the opposite seems to have been the case. Today there is even more interest around climate change and ESG and more urgency to have some sort of opinion or investment focus on these areas.”

“From an investment standpoint responsible fixed income investments – such as impact bonds designed to deliver specific ESG related outcomes – have gained significant popularity in recent months. That said, these products do require careful analysis of their fundamentals, purpose and the means to measure their effectiveness and value. It is also important to remember that responsible investment (RI)is a relatively new area that is evolving all the time and that bonds issued with an RI label can require very careful scrutiny in terms of their purpose and credit ratings,” she concludes.

1 CNN. A major recession is coming, Deutsche Bank warns. April 26, 2022

 

Disclosure/hedges

This material has been provided for informational purposes only and should not be construed as investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others.

Bonds are subject to interest-rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines.

Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.

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