Active, global fixed income the key to investor returns in 2022


MEDIA RELEASE: The biggest risk and opportunity for fixed income investors in 2022 will be inflation, says Stuart Dear, Schroders head of Australian fixed income.

“The past two years have been challenging for fixed income investors. There has been extraordinary intervention in markets by central banks, we have seen cash rates and bond yields suppressed at low levels and now we are seeing rising inflation risks,” Mr Dear said.

“All of these risks mean there is ongoing uncertainty in fixed income markets, but this uncertainty can also bring opportunity for active managers.

“One of the key questions will be: what is the demand response going to be to higher inflation?”

“We know corporates have done a pretty good job of passing through higher costs to consumers – revenues have been strong and volumes have been high so margins are staying reasonably elevated. But this is unlikely to last.

“At the moment the corporate credit risk premium is clearly tightly priced. Arguably, given the strength of corporate balance sheets, that is justified. But as you move forward in the economic cycle, the ability of corporates to pass those costs on becomes more challenged. It may be that funding costs start to go up, or it may be that wage price pressures start to come through.

“In light of this, we believe corporate credit markets are in a carry phase with limited prospect for capital growth in the near term. In fact some of the challenges coming through in the next phase means there will be businesses that fail.”

Mr Dear says this volatility in the corporate credit market will reverse the trend of the very low corporate credit default rates we have seen in recent times.

“The volatility this movement in corporate credit creates will present opportunities for active fixed income managers.”

Schroders portfolio manager fixed income & multi-asset, Mihkel Kase, agreed, and said in this environment diversification across asset classes and strategies will be key to navigating potentially more volatile markets ahead.

“Global Fixed income markets are larger than equity markets – and within that you get a wide range of opportunities with a great depth and breadth across a global universe.”

Looking ahead to 2022, Mr Kase says investors will benefit from adopting two complementary fixed income investment approaches.

“The opportunity for investors is to gain exposure to traditional active fixed income – where duration exposure can diversify equity market risk – as well as to fixed income exposure in the absolute return space to manage income needs.

“As investors move into 2022, both approaches can play an important role in fixed income portfolio construction. Both invest through a different lens but they are complementary approaches.”

With signs that some investors are moving out of fixed income and into cash, Mr Dear said that it is important for investors to remember the strategic role of fixed income in a portfolio.

“Fixed income provides low risk return and diversification that should benefit investors through time.”

And although some investors have cycled out of bonds and into cash, he says it is not a position he would advocate.

“We wouldn’t advocate a wholesale reduction out of fixed income into cash.

“Tactically, as fixed income managers, we are managing our allocations. In our portfolios we have reduced duration, we have added some inflation linked bonds, we have built up some cash and we have trimmed out some credit.

“But by remaining strategically invested in fixed income, investors are likely to earn a better income yield than cash offers (the Schroder Fixed Income Fund currently yields 2.7%) and retain diversification benefits that bonds provide. And we are actively managing portfolio positions and are ready to take advantage of better opportunities ahead.”

Mr Kase added that an active manager in this environment can position the portfolio to take advantage of opportunities across global fixed income markets.

“For instance, we have been cutting credit risks out of our portfolios as valuations become more compressed. But we have also been taking advantage of pockets of opportunity such as in Asian credit markets where valuations have significantly adjusted,” he said.

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