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Wise’s Ropers: Bonds are back on the table as value emerges

10 August 2022

The manager explains why fixed income is starting to look attractive and the two bond funds has been adding to in his TB Wise Multi-Asset Growth portfolio.

By Vincent Ropers,

Wise Funds

The first half of 2022 was a bracing period for investors, with equity and bond indices registering their worst first-half returns for about half a century. Rampant inflation was largely to blame, forcing the US Federal Reserve to hike rates by the greatest margin since 1994, despite previously ruling out such a scenario. However, the market backdrop is evolving.

Over the last month, there has been a noteworthy shift in how the market perceives the ongoing battle to curtail rising prices. It appears inflation is now very much a known risk and largely priced into markets, with the risk of global recession now seemingly taking its place as the principal concern among investors.

Analysis of the US two-year breakeven rate, which provides a good indication of the level of inflation in two years’ time priced in by the market, indicates we are past the peak in inflation expectations. In March, the rate suggested about 4.7% of inflation was priced in. Today, this figure has fallen to 3.2%, indicating within the space of just three months, inflation expectations have declined 1.5% in the US for the next two years.

The commodities market also implies recession fears are trumping those of inflation. The price of copper, which is a strong indicator of industrial activity, has fallen off a cliff in recent months, while the prices of other key industrial metals including aluminium and even silver have also witnessed considerable declines.

 

On board with bonds

This marked shift is unearthing compelling opportunities in assets previously out of favour with growth investors. Specifically, we believe pockets of fixed income look increasingly attractive in the macroeconomic environment fast emerging.

Although high inflation and rising interest rates are generally strong hurdles for the fixed income market, a good degree of downside already being priced in means yields now offer a greater degree of protection, at around the 3% level in US 10-year government bonds, 2% in the UK, and 1% in Europe.

With the recession risk now looming large, we believe traditional bonds should increasingly act as a diversifier to equities.

In recent months, bonds have increasingly performed well when equity markets have struggled. In the first half of the year, the S&P 500 was down 20%, while the broad US aggregate bond market was down 10%. Since the 1970s, this is the first time bonds have not delivered positive returns when equities dropped by such a magnitude. With current bond yields offering a greater margin of safety, we feel a compelling opportunity has arisen, and we are subsequently allocating towards traditional bond strategies for the first time in years.

We recently initiated a holding in the Vontobel TwentyFour Strategic Income fund. We feel this strategic bond fund should provide a good degree of upside moving forward, as well as attractive levels of portfolio protection. The bulk of its exposure is tilted towards credit as opposed to government bonds – a much more natural fit for multi-asset growth strategies. The managers also have the ability to actively manage the duration in the portfolio. Meanwhile, the fund’s diverse credit exposure is looking particularly attractive at current levels.

While we only have a modest allocation at present, we will continue watching the space closely and increase our exposure incrementally should market conditions justify doing so.

 

Don’t forget floating rate

While a moderate allocation to traditional bond strategies seems sensible at present, it is also vital growth investors do not overlook wider areas of fixed income that remain compelling in the current inflationary environment. Specifically, investors can ensure an attractive level of portfolio diversification by allocating towards bond strategies that invest in asset-backed securities.

TwentyFour Income – another strategy managed by TwentyFour Asset Management, but distinct from the TwentyFour Strategic Income fund – is an investment trust that invests in relatively high-yielding asset-backed securities, including mortgages, credit card debt and auto loans. The quality of the credit work from the team at TwentyFour provides protection on the downside, while the fact asset-backed securities use floating rather than fixed rates – whereby coupons payable rise in tandem with interest rates – offers a meaningful hedge against rising rates.

As such, a sensible allocation to bond strategies can provide considerable portfolio protection amid an increasingly uncertain macroeconomic environment, as well as the potential for attractive capital growth over the near and medium term.

Vincent Ropers is portfolio manager of the TB Wise Multi-Asset Growth fund. The views expressed above should not be taken as investment advice.

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