Sailing the seas of resilience and selectivity

Just like skilled sailors who thrive in favourable winds, the fixed income market – from the most liquid and highest quality issuers, to emerging market local currency and high yield names on a selective basis – continues, in our opinion, to chart its course towards success in 2023.

After navigating the tumultuous waves of 2022, the fixed income market has been finding solace in the performance of the first six months of 2023. Valuations have readjusted, providing what we believe to be a more favourable starting point for investors to set their sails.

Riding the Waves of Yield

Just as skilled sailors ride the waves with finesse, investors in high yield and investment grade corporate bonds have seen their strategies often pay off with low single-digit returns year-to-date. While it hasn’t always been smooth sailing, the dramatic movement at the short end of the yield curve has allowed investors to navigate the shifting tides. In recent years, yields on 2-year US Treasuries, 2-year UK Gilts and 2-year German Bunds have surged by 375 and 400 basis points (bps), while corporate bond yields have reached close to their highest levels in over a decade.

Discovering New Horizons

EM local currency bonds emerged as the shining stars in the fixed income universe, much like hidden treasures waiting to be discovered. With the decline in the US dollar this year, these bonds often reflect the value that has returned to government bonds in emerging economies, offering investors the potential for a voyage into promising opportunities.

Flexible bond strategies act as nimble vessels, taking advantage of relatively cheap currencies in emerging markets. Like explorers venturing into unchartered waters, these strategies capitalize on the potential growth rates offered by emerging markets, thanks to their lower government debt levels relative to the size of their economies and better valuations.

Harnessing the Power of Favourable Winds

Just as the winds of change make a sailor’s journey more favourable, the nearing conclusion of the prolonged Fed-led interest rate hiking cycle in developed markets has made bond yields, in our view, more attractive. Like a ship with its sails full, buy-and-hold portfolios could seize the opportunity to secure a return of 1.5% plus inflation on 30-year US Treasuries – an unprecedented possibility in over a decade.

In the face of a potential US recession, we believe the bond market displays remarkable resilience, mirroring a sturdy vessel sailing through turbulent waters. The strength of high-quality issuers becomes evident, as they are expected to navigate the challenges of 2023 with poise and success.

Seeking New Shores of Returns

Amidst the voyage through the fixed income landscape, investors find favourable comparative analysis in emerging markets. The  yields on 10-year sovereigns, minus forward-looking inflation expectations in countries like Brazil, Colombia and South Africa stand around 6% in real terms. Following closely are Peru, Mexico, Poland and  India  offering over3%These alluring real yields overshadow the US, which stands around 1%

Anchoring with Quality and Care

Just as a well-maintained vessel provides stability in stormy seas, the corporate sector has so far demonstrated  resilience in the face of higher-for-longer interest rate environment. With overall relatively low leverage and interest coverage close to all-time highs, companies stand firm, offering support to bond investors. In our view, to ensure a smooth journey, a selective approach focusing on quality names and less cyclical sectors becomes essential, akin to navigating through treacherous waters with care.

As the fixed income market embarks on a remarkable journey in 2023, driven by resilience, selectivity and the ability to adapt to changing winds, we believe investors can navigate the seas with confidence. Guided by the compass of opportunities and the sail of favourable market conditions, backed by the power of resilience and the strategy of selectivity, investors could discover hidden treasures in emerging markets and potentially harness the power of higher yields and attractive returns. A rewarding 2023 is possible, in our view in the vast and promising world of fixed income.

*This article was first published, in Chinese, in the Hong Kong Economic Journal.