Paul Skinner, investment director at Wellington Management, said both risk assets – including credit – and safe haven assets, such as government bonds, “have yet to establish any meaningful direction” due to high uncertainty over an upcoming recession.
He described the uncertainty as “the start of a classic inflection point”, predicting current market volatility may take “the whole year to resolve”.
“We think the solution is to sit in the least volatile asset class – fixed income – and benefit from the prospect of what has become a healthy annual yield while we await the outcome,” he argued.
Peter McLean, portfolio manager at Stonehage Fleming Investment Management, argued as markets continue to warn of an upcoming recession, government bonds represented “an attractive safe haven”.
While rising yields “punished” bondholders last year, McLean said investors could now gradually build an allocation to appropriately valued government bonds, offering portfolio protection in the event of negative economic or market shock.
McLean said central banks were likely close to the end of or at the peak of the rate hiking cycle, meaning ten year bond yields “are likely to be near the top of their trading range for this cycle”.
“Historically, the US ten year yield has declined by around 2.5% during recessions, offering the prospect of valuable double-digit returns against a backdrop of volatile equity markets,” he said.
‘Number of opportunities’
Robert Dishner, senior portfolio manager at Neuberger Berman, said there were a “number of opportunities” in the fixed income space due to dispersion in credit markets and developed economies avoiding recession so far – although Germany tipped into a technical recession on 25 May following the release of revised GDP figures.
Dishner pointed to the UK, noting the stronger-than-expected performance of the economy, as well as continued rate hikes.
Earlier this week, the International Monetary Fund upgraded its outlook for the UK , no longer forecasting a recession but instead predicting it will maintain positive growth for the year.
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According to Dishner, these dynamics provide investors in the new issue market both the ability to receive higher coupons but also to gain exposure to quality assets.
“We will continue to focus on income opportunities as a result of the move in rates,” Dishner concluded.
Oliver Faizallah, head of fixed income research at Charles Stanley, said the inversion of the UK yield curve revealed “huge merit” in shorter dated GBP credit, rather than “going further out on the yield curve for no additional yield”.
“Short-dated investment-grade bonds provide protection in portfolios in times of market stress thanks to their sound credit quality, which becomes more of a factor in periods of credit weakness,” he added.
However, Faizallah still recommended a “barbell approach” to maintain a neutral portfolio duration, through allocating to longer-duration sovereign bonds.
He pointed to the AXA Sterling Credit Short Duration Bond fund as a way to gain exposure to short duration GBP credit, arguing the fund invested in “the higher-quality part of the investment-grade universe”.
“While we believe that we are approaching terminal rates, as increasing presence of economic pain suggests there is only so much more room for further rate hikes, inflation remains sticky meaning the Bank of England will likely have to hold rates at high levels for some time,” said Faizallah.
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Meanwhile, Skinner argued that due to the “indecisive trading range”, the valuation for risk assets was not appealing and would need “a significant sell-off” for to create opportunity in the sector.
Instead, investment grade credit looked more appealing to Skinner, as it was currently yielding over 5%, compared to around 2% at the end of 2021, he said.
“These can protect you in a credit crunch, which would likely trigger central banks to lower interest rates,” he added.
“If ever there was a time the diversifying qualities of fixed income are required in portfolios – we think this is it.”
The US
The US appealed to Dishner, particularly given the relatively minor contagion seen as a result of recent US banking failures.
“US mortgages screen well, while to no surprise, corporates with little pricing power and excess inventory do not,” he added.
Stonehage Fleming’s McLean also warned the credit cycle posed “a threat” for lower quality fixed income, highlighting high yield credit as a potential risk as spreads over US Treasuries “remain modest”.
