With bond yields returning to some of their highest levels since the global financial crisis and some investors reporting marked improvements in the investment grade (IG) credit market, we believe fixed income can offer some compelling opportunities in the months ahead.
In particular, we believe value is back in investment grade bonds and see strong return potential in both the global and regional markets. Overall leverage levels also remain below their peak during the Covid-19 pandemic.
It is possible some fixed income assets classes could offer better returns than equities this year, with so-called ‘fallen angels’, short-dated high yield bonds and emerging market (EM) corporate fixed income looking like particularly positive prospects for investors in 2024.
Across fixed income, generally yields appear quite high relative to history and are certainly the highest we have seen since the global financial crisis.
All of this comes amid a backdrop of central bank intervention to hike interest rates in order to dampen inflation. In this environment, investors will need to pay careful attention to the speed and degree of any interest rates cuts likely to upset bond markets.
While it looks likely interest rates have now peaked and policy decrees they are on hold for now, the question is, ‘how quickly will central banks go the other way in reducing rates?’
Uncertain backdrop
Yet central bank movements will not be the only market distraction in 2024. Amid a worsening geopolitical climate – with ongoing Russian military action in Ukraine and a recent escalation in regional conflict in the Middle East – the world could face a pivotal year.
We can point to an unusually high number of upcoming national elections, including a US presidential election and possible UK general election, later in the year. This year marks a significant increase in potential volatility from election cycles.
A higher volatility market environment lends itself to active management, as it could potentially give managers an opportunity to show their true worth in navigating market pitfalls to protect investors and deliver strong returns.
Further, a global approach could also help exploit opportunities in a broader pool of assets than more localised, country or region-specific strategies.
The ability to shift allocations within this can, in some cases, help investors outperform and mitigate drawdowns. Global credit also tends to do particularly well versus regional credit when markets are coming out of a downturn and can offer more scope for better returns.
Market divergence
Looking at the scope of opportunity across global credit markets, there is divergence between European and US credit, and active managers can potentially pinpoint specific pockets of opportunity.
One interesting facet of the current market is that there is still a gap between euro and dollar credit spreads. We believe European spreads are still cheap relative to US peers, even adjusting for some problems in the European real estate market.
Elsewhere emerging market debt should not be overlooked. While investors should proceed with caution, EM corporate debt risk levels are often lower than many imagine.
We believe emerging market corporate fundamentals can provide a strong buffer against lower global growth and, perhaps surprisingly, net leverage across EM debt remains lower than in many developed markets.
In our view, EM corporate debt is an asset class of significant size which can offer genuine value and opportunity in a global context when adjusted for ratings and fundamentals.
Peter Bentley is co-manager of the BNY Mellon Global Credit Fund and deputy CIO of fixed income at Insight Investment. The views expressed above should not be taken as investment advice.