There are appealing fixed-income opportunities in important assets and sectors despite growing inflation and ongoing economic uncertainties.
Even though active fixed-income investors came into the new year with a wide range of economic expectations, the lack of consensus in the market gives them a wide range of choices for which assets to buy.
The market’s most important variable is, of course, inflation. If it proves to be temporary and eventually recedes sufficiently this year, the U.S. Federal Reserve may only tap the brakes when it comes to raising interest rates and unwinding asset purchases, allowing the economy to heat up while keeping default risks low. Nevertheless, if inflation persists and becomes a greater obstacle, the Fed may tighten financial conditions, reducing future growth and increasing the danger of default. Both scenarios would have a substantial effect on asset prices.
Current bond market pricing predicts a short, but abrupt, tightening cycle from the Fed, and the flattening of the yield curve since the fourth quarter of 2017 indicates that future growth is likely to slow. Many indices are already pricing for this outcome, and in our search for returns in excess of benchmarks, we find the most enticing fixed-income investments in four major areas: investment-grade corporate bonds, high-yield bonds, securitized credit, and emerging-market debt.
Select Corporate Bonds with Investment-Grade Ratings
We expect the greatest return potential among corporate bonds with a relatively low default risk in financials, which could benefit from interest rate increases. Additionally, financial organizations have the ability to adapt to greater inflation risks than other market sectors.
Among nonfinancial, we like corporate bonds rated BBB; we are wary of those rated A or higher, which tend to have longer maturities and be more interest-rate sensitive. Investors should also be aware of companies with risks of mergers and acquisitions, since companies that change their capital structures may lower the value of their bondholders.
High-Yield Bonds in Particular Industries
Although absolute spread levels in high-yield bonds are close to being fully priced, sector values are appropriate relative to one another. We choose short-term high-yield debt because it is less vulnerable to changes in interest rates than the broad index.
Our baseline assumption is that interest rates will rise, but economic conditions will remain robust. As a result, the risk of default may stay low, and short-term, high-yield debt, like bank loans, is a way to get a bigger return while possibly lowering interest-rate risk.
By rating cohort, we see value in single-B-rated bonds, which are seen as the sweet spot in the high-yield universe due to their higher spread or yield, lower interest-rate sensitivity, and higher credit quality than BBs and CCCs. Default risks may stay modest, and we believe single-B bonds offer a favorable risk-to-return ratio.
We favor the following sectors for tactical and opportunistic investment opportunities:
- Should energy prices rise, so will the cost of energy.
- Expect instability in cable, media, and broadcasting in the near future and look for opportunities to buy at attractive levels.
- retail, owing to solid consumer fundamentals and
- There may be a rise in demand for and prices of real estate-related materials.
Credit Securitization as a Short-Term Production
Additionally, as a short-duration asset class with decent yields and excellent credit fundamentals, securitized credit will remain alluring. Both the U.S. and European housing markets are still getting a lot of help from the rising prices of underlying assets and the fact that borrowers are good at paying back their loans.
However, we are cautious about commercial real estate, although this varies widely by industry. In 2022, agency mortgage-backed securities may lose the boost from Fed purchases and become cheaper.
Debt on Emerging Markets and Currencies
After falling behind in 2021, emerging market debt has significant capacity for growth this year. In order to combat inflation threats, central banks in developing countries have significantly outpaced those in developed markets in hiking interest rates. If inflation stabilizes in 2022 as predicted, local emerging-market debt and currencies are likely to appreciate as global investors become drawn to this asset class’ yield, carry, and potential returns.
What’s the fixed income and portfolio management ?
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Bottom Line : Investment-grade corporate bonds, high-yield bonds, securitized credit and emerging-market debt are among the most enticing fixed-income investments. But if inflation persists, the Fed may tighten financial conditions, reducing future growth and increasing the danger of default. We see value in single-B-rated bonds, which are seen as the sweet spot in the high-yield universe. We favor the following sectors for tactical and opportunistic investment opportunities:. Expect instability in cable, media, and broadcasting in the near future and look for opportunities to buy at attractive levels.