Fixed income, rising like a phoenix from the ashes, or “bond yield trap”?
Following the worst year ever recorded in the modern financial market history for fixed income investors, and the end of a prolonged period of zero to negative interest rates, we are experiencing an increasing market demand on bond strategies, led mostly by increasingly attractive yield perspective. In the current uncertain market environment, it is crucial for asset managers to avoid potential “bond yield trap” and invest in strategies with an appropriate risk/return profile, especially on cautious mandates.
Mildly positive 2023 outlook on fixed income
Tightening monetary policies of the major central banks to face surging inflation led to significant market drawdowns among bond markets, with 10Y govies back to interesting positive yields after a prolonged period of low to negative yields and monetary stimulus which had been sustaining the economy for more than 10 years.
In this still uncertain market environment, the latest macroeconomic data released seem to provide encouraging signs that central banks are succeeding in slowly easing inflationary pressure, although they have not yet caused serious negative impacts on the economy's leading indicators and the labor market ( mainly in the United States). Analysts and strategists increasingly agree that there is a favorable outlook for a rebound in fixed income in 2023, with attractive yield opportunities in the IG bond segment, especially in Europe.
The energy crisis, weakening EUR/USD and heightened systemic risk have led to an indiscriminate dislocation of the EU credit market. The credit market has reflected the deteriorating economic environment faster than the equity market. Both IG and HY credit spreads have widened significantly over the past 12 months and appear increasingly attractive compared to historical peaks. While an increase in defaults might be a reasonable scenario among EU HY issuers, EU IG spreads have a better risk/return ratio and a very attractive yield perspective. As an example, major European banks should benefit from rate hikes and they exhibit a high level of liquidity and a low level of nonperforming loans.
SFDR as supporting framework for fixed income demand increase
Recent regulatory updates on sustainable investment have had a positive impact on demand for fixed income.
In fact, after some delays to allow market participants to align with the new EU taxonomy, the SFDR Level 2 finally came into effect on January 1, 2023, which began to require asset managers to comply with the "Regulatory Technical Standards" (RTS), to disclose information related to the taxonomy, and to provide periodical disclosure templates for products under Articles 8 and 9 of the SFDR.
Demand for sustainable investment strategies from institutional investors has increased notably, and major companies have begun not only to disclose their sustainable metrics but also to incorporate them concretely into their corporate strategies. This has led not only to an increase in green bond issuance, but also to an increase in the extra-financial profile of "classic" sectors and issuers, which has allowed for an increase in the eligible universe for ESG indices and passive strategies and, as a result, an increase in the number of fixed income ETFs focused on companies with a higher ESG profile.
FARAD I.M.’s investment approach
In this framework, a detailed risk/return analysis on financial fundamentals, together with selection based on issuers with a high ESG profile, should be the basis for prudent investors to avoid incurring in liquidity problems. Nevertheless, this may not be sufficient. The current uncertain market environment requires continuous oversight of macroeconomic data developments, and the recent increase in volatility could still affect the main fixed income segments in the medium term.
In this regard, the European investment grade segment could be well positioned to profit from last year's significant retracement and increasingly attractive returns; in addition, companies with a high ESG profile could benefit from the prospect of capital flow coming from passive strategies.
Complex solutions that also provide potential capital protection could be an attractive opportunity. At FARAD I.M. we are able to provide tailored strategies that could be structured to participate in the EU IG within companies with high ESG scores, with a focus on low carbon/ GHG emission companies and with positive alignment to the 17 UN SDGs.
As an additional example of our commitment to sustainable investing and tailor-made solutions, FARAD I.M. has developed a unique sustainable investment product, called "AMC Energy Transition & Human Capital" ("AMC ET & HC", ISIN CH1185519621), which invests in companies with significant alignment in their revenues with the SDGs ("UN Sustainable Development Goals") involved in two specific sustainable clusters, "Energy Transition" (SDGs involved in environmental goals, such as SDG 7 "Affordable and Clean Energy," SDG 13 "Climate Action," or SDG 12 "Responsible Consumption and Production"), and "Human Capital" (such as SDG 3 "Good Health and Well-Being" or SDG 6 "Clean Water and Sanitation").
If you would like to learn more about our sustainable investing products and services offering, please contact CRM@greenethica.eu.
Head of Portfolio Management