Unlocking the value in fixed income

How well or poorly bonds perform in the market is often viewed as a good way to tell how the economy is doing. Still, it may be truer to say that how bonds are doing now reflects what an investor expects to see the future economy do 6 to 12 months down the road. In this way, the bond market is a top indicator. Responsible investing has traditionally focused on equities, given shareholders’ ability to influence management decisions. But as responsible investing evolves, some global institutional investors are widening their focus to include fixed income.

Bondholders can also have a far-reaching influence over governments and companies. Fixed-income investors may seek to engage with debt issuers to understand better the environmental, social, and governance risks they face, evaluate how they manage them, and encourage them to improve their practices.

The centrality of fixed income is illustrated by the amount of global issuance, which is many times larger than the equity market. The role of these assets in investor portfolios, and their dominance across global markets, mean these assets cannot be ignored as investors seek to invest responsibly in pursuit of their goals.

What is your assessment of fixed income markets today?

Fixed income markets are facing challenging times. However, they are no more complex than those we have seen over the last ten years.

If we cast our minds back to the 1990s, the fixed income environment was fundamentally different. When the French Treasury issued France’s first inflation-indexed bond in 1998, it came with a nominal yield of around 5% and a breakeven rate of 2%, giving an actual output of 3%.

Today, the breakeven inflation rate is roughly similar, but the actual yield is negative at around minus 1.5%. That is a dramatic change, but low real yields are something we have had to live with for the last ten years.

There have been structural changes in fixed income markets. There is no reason to expect real yields to rise significantly soon. This expectation is an essential element in the vision of the limited income opportunity set.

The usual approach involves combining two distinct investment styles: 

  • The long-term investment approach is used to select securities for buy-and-hold insurance portfolios by applying a ‘buy-and-enhance’ mindset to investing. Each investment is analyzed concerning the value it can generate in the long term. Dedication to detail and rigorous analysis in a security selection is at the heart of the process.
  • An active approach with a shorter investment horizon generates total returns relative to a standard multi-sector eurozone benchmark (such as the Euro Aggregate index). To actively manage duration exposure, positioning on the yield curve, issuer selection, and placing within the issuer’s capital structure. 

Each of these investment styles has strengths and weaknesses. By combining them, you are seeking to take the best attributes of each. The result is a rigorous identification of fixed-income instruments offering potential value over a long-term investment horizon. You are seeking to unlock the potential for solid returns across the full spectrum of selected income markets.

So fixed income offers an alternative to equities today?

Yes, of course. Equities are nothing more than that sliver of hope that separates assets from liabilities.

On the other hand, fixed income instruments provide investors with a clearer visibility in that the cash flows are specific over a longer horizon. There may be periods of volatility when the performance of our high conviction strategy lags behind that of the benchmark.

The value of investments and the income they generate may go down and up, and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets or specialized or restricted sectors is likely to be subject to higher-than-average volatility due to a high degree of concentration, more significant uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).  

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation, and conservation on behalf of funds invested in emerging markets may carry greater risk.