30 Jan 2024
Artemis’ fixed income team share their three key messages for 2024.
Bonds of almost every variety are a ‘buy’
High-yield bonds are attractive under almost any economic scenario
Changing market conditions make taking an active, bottom-up approach to bond markets a necessity
Stephen Snowden - Manages: Fixed income strategies
Back in late 2006 and early 2007, when interest rates in the UK were last above 5%, conditions were nothing like they are today. It was boomtime and Northern Rock was happy to offer you a 125% loan-to-value mortgage. At the risk of pointing out the obvious, we are not in the middle of an economic boom today. Interest rates will have to fall from here. They are simply out of step with reality. In the bond market, meanwhile, yields are higher than they have been for nearly a generation. And bonds typically perform very, very well when the Bank of England starts cutting interest rates.
I have been working in fund management for almost 30 years. One thing I’ve observed over the decades: it is rare for bond managers to express much excitement about their funds. The stereotypical bond manager is someone boring, scrupulous and more concerned with downside risk than upside potential. Like many stereotypes, this one has some basis in truth. It is rare for us to start banging on our desks and urging you to buy bonds. But when we do, it might be worth listening.
Jack Holmes - Manages: ‘Global high yield', 'High income', 'monthly distribution', 'Target return bond'
The market recently became excited about the prospect of a ‘soft landing’ in the US. While that’s certainly an appealing prospect, it’s a narrative I struggle to embrace. Monetary lags are unpredictable in their timing and their impact and economic downturns are self-reinforcing. That makes the task of central banks – to tighten just enough to slow the economy without causing meaningful damage – incredibly hard to achieve. Today’s unprecedented environment (inflation, deglobalisation and the inflated balance sheets of both central banks and governments) makes it unlikely that central banks will succeed in striking the perfect balance between cutting rates too early – and leaving it too late.
So there’s a huge degree of uncertainty. At the same time, high-yield bonds appear attractive under almost every scenario. If rates hover around their current levels, high-yield bonds can provide investors with attractive total returns. From November 2022 to November 2023, yields in the global high-yield bond market barely moved but a sterling investor would have made 8%*. If there is an economic downturn or risk-off move, the high level of starting yields will help to offset any capital losses: yields would have to rise to well over 10% for investors to experience an outright loss. And if yields fall, there is the potential to make significant capital gains.
David Ennett - Manages: ‘Global high yield', 'High income', 'Monthly distribution', 'Strategic bond'
In the era of quantitative easing, the key decision for managers of strategic bond funds was deciding on the right mix of government bonds, investment-grade credit and high-yield to hold; performance largely reflected how adept a given manager was at managing that mix. That allocation decision is still important, but the real opportunity now – and where we think additional value is to be added over the coming years – is what investors do within each of those areas.
The withdrawal of QE introduces fundamentally different conditions to bond markets. As QE is reversed, we are seeing more volatility and greater dispersion. The bottom-up opportunities within the credit market have increased. As a result, the decision that managers of strategic bond funds need to take in 2024 is not simply whether to increase or decrease the fund’s high-yield beta or its duration: stock selection matters once again.
*Source: Lipper Limited; ICE BofA Merrill Lynch Global High Yield Constrained GBP Hedged Index to 30/11/2023.
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