Bonds have not been a safe place for investors to hide so far in 2022. The Bloomberg Global Aggregate index – which tracks the performance of global investment grade bond markets – is down 6.4% year-to-date.
This marks one of the rare occasions that a bond index has performed worse than a global equity index. The MSCI World index is down only 4.3% over the same period.
Performance of bonds vs global equities year-to-date
Source: FE Analytics
Much of the move in bond markets has been attributed to investors positioning for more persistently high inflation and for a rapid tightening of monetary policy from the US Federal Reserve and other major central banks.
Amidst this backdrop, bond managers share with Trustnet how they are managing their asset allocation in response.
Tony Carter, fixed income & multi-asset portfolio manager at Sarasin & Partners, is buying long inflation breakevens – which is buying an inflation-linked bond and selling a government bond future or selling interest rate swaps.
He said: “We are long 30-year UK breakevens based on the looming supply-demand imbalance (demand from UK defined benefit pension schemes to greatly exceed supply from HM Treasury in the coming years) – this has done well this year, admittedly boosted more by the leap in commodity price inflation arising from the Russian invasion of Ukraine than by our original investment thesis, although we do think this remains intact longer-term.”
Another area that is doing well is emerging market local currency, which he said are well-positioned to benefit from the jump in commodity prices, which on the supply side has been boosted by interruption to Russian supply and on the demand side by policy easing in China, “although the ‘zero Covid’ policy does jeopardise this to some extent”, he said.
The best performer so far has been the Brazilian real, where he owns AAA-rated supranational issuers.
He said: “These have produced roughly flat returns in local currency terms, but hugely positive returns in base currency terms – BRL has returned +22.5% against the dollar and nearly 27% against the pound this year.”
Amidst rising inflation, Fatima Luis, a fixed income portfolio manager at Mirabaud Asset Management, is sticking to her positioning in Travel, Leisure and Energy sectors as part of her team’s post-Covid economic normalization trade.
“High savings rates among consumers in the US and Europe and a healthy employment picture supported this view,” she said.
“We felt inflation would be a key concern and therefore kept our duration positions relatively short. We were wary of holding too much low spread and high interest rate sensitive credit.”
Given the invasion of Ukraine by Russia, she has also implemented some US Treasury hedges in the five-year part of the market and some 10-year Bund futures to manage euro denominated exposure. Relative to the US dollar, the euro has declined 4.7% since the start of 2022.
Performance of Euro year-to-date relative to the US dollar
Source: FE Analytics
Luis has also been slowly adding to better quality credit in the secondary market because investment grade spreads are starting to look “very attractive” from a longer-term perspective.
Ashok Bhatia, deputy chief investment officer of fixed income at Neuberger Berman, said he expected inflation rates to peak this spring, but that inflation will remain a key factor for many quarters to come.
“Any fall will likely leave inflation rates in the US and Europe at or above target levels over the next 12 months,” he said.
One way he is positioned is by maintaining relatively low duration, or portfolio interest rate sensitivity – positioning for the yield curve to remain flat or continue to flatten.
“In essence, we expect the inflation environment to drive the Federal Reserve (Fed) to continue hiking,” he said.
Bhatia has also increased weighting to sectors that should have less sensitivity to rising interest rates – such as bank loans, collateralized loan obligations (CLOs), and securitized credit that have floating rates.
He has also focused on sectors that should have stronger revenue growth such as travel and leisure, instead of sectors that could see pressure from rising interest rates, such as housing.
“In essence, we are focusing security-level investments in sectors and companies that we believe to be relatively insulated against, or even potentially beneficiaries of, this inflationary environment,” he said.
While most managers continue to position for higher inflation, Chris Higham, senior portfolio manager at Aviva Investors, is unwinding his.
He has long held the view that the only way out of the indebted situation of most countries was through inflation and has already been positioned for the recent moves in the bond markets.
He started the year with short duration, long inflation and defensive credit positioning in his funds relative to their respective benchmarks.
But given that bond markets have already started to reprice a lot of the uncertainty as yields rise, Higham has started to reduce his long inflation positions and started to selectively add to long duration positions in certain markets.
“Whilst credit markets are now offering better value than at the start of the year, and indeed global high yield is now a more attractive yield in excess of 6%, we continue to think that credit markets may well need to price in more of this uncertainty,” he explained.
“There are clearly going to be sectors that stand to benefit from these trends, but as a credit investor the key will be to avoid those sectors that are under pressure.”