Fixed Income

In the past decade or so the additional tier one (AT1) market has experienced occasional semi-cathartic events that naysayers jumped on to pronounce that the market is dead. Of course, this was never true, just as it isn’t true this time. It usually ends the same way – with some unfortunate casualties, but also plenty of opportunities.

Amid aggressive monetary tightening, the short duration profile of high yield bonds can help defend against rising rates.
Short-dated high yield bonds can offer enhanced yield, lower duration and higher risk-adjusted returns.
In the current environment, short-dated high yield bonds present interesting investment opportunities as they offer over 90% of the yield of the overall high yield market with about half the typical duration risk.

KEY TAKEAWAYS • The excess yields available from investment-grade and high-yield corporate bonds are beginning to attract “crossover” investors • Asset-backed securities look attractive in the current rising interest rate environment given their shorter duration • Including securitised credit in a fixed-income portfolio could provide diversification benefits due to its lower correlation with corporate credit • Security selection will likely be the key to alpha generation for securitised credit in the coming years.

Key Takeaways: Caution is warranted entering 2023, however volatility could present intriguing buying opportunities • Although headwinds persist, the solid fundamental starting point should help most companies weather a slowdown and result in a persistently low default rate • Spreads could widen if a recession becomes more imminent. However, elevated yields and discounted bond prices look attractive and we believe high yield could surprise to the upside and generate coupon-plus returns.

In recent years alternative fixed income assets such as mortgage loans, infrastructure financing and private debt have become much more important categories for institutional investors. They can provide opportunities to increase portfolio yield when the (often lower) liquidity of these assets is not a constraint. This is typically the case for long-term investors, such as pension funds and life insurance companies.

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An allocation to high-quality, developed market government bonds continues to play an important role in reducing the volatility of a well-diversified portfolio. However, there is no getting away from the fact that, despite recent rises, yields in developed country bond markets are low by historical standards and often fail to compensate even for relatively modest projections for inflation. Given the secular forces that have led to the long-term decline in equilibrium real interest rates, this situation is likely to persist. An allocation to Emerging Markets Debt (EMD) can complement traditional fixed income by enhancing long run returns and acting as an important diversifier within global portfolios.