24 May 2021
With talk of central bank tapering increasing, how should fixed income holders approach this environment? Fidelity Strategic Bond Fund Investment Director Steve Bramley discusses why it need not be all doom and gloom, while also outlining some of the opportunities emerging in higher beta areas like high yield and emerging market debt (EMD).
Key points
There is certainly plenty of good news and optimism factored into markets at present. As a case in point, year-to-date inflows into global stocks have been roughly two-and-a-half times the rate of inflows into global bonds. However, such optimism seemingly heightens the risk of some form of disappointment further down the line. This could also prove to be a reasonable incentive for more cautious investors to de-risk, given the magnitude of total return gains from riskier assets over the past year.
But with talk of tapering from central banks also picking up, should prospective bond investors proceed with caution? We think not, provided that forward guidance is clear and credible. Tapering, like taxes, is inevitable, and the upward move in bond yields and forward expectations suggests markets may have already moved in anticipation.
Bond yields and survey forecasts
Source: Fidelity International, Bloomberg, as at 3 May 2021. Market yield forecasts = Bloomberg’s weighted average of bond yield forecasts from a survey of market analysts.
Due partly to mounting global debt levels, the authorities seem noticeably mindful of the need to manage their message carefully. Of course, that is easier said than done and there is always a risk of miscommunication or misinterpretation by the market. However, we take comfort in the muted market reaction to the recent hawkish message from the Bank of Canada, which included a 25% reduction of asset purchases, as well as steady recent communication from the US Federal Reserve. The latter reiterated the need to see "substantial further progress” towards its goals, especially regarding the labour market, before adjusting asset purchases.
On the asset allocation front, we have a clear preference of late for high quality government and corporate bonds within our portfolios. However, that is not to say that there aren't opportunities in the “higher beta” areas of fixed income markets, especially when you consider the recent lack of corporate defaults, which has run contrary to expectations from only a few months ago.
Several spread widening episodes in the emerging market debt (EMD) space, for instance, have presented us with some unexpected opportunities. As a result, and on the back of a quarter to forget for EMD as an asset class and the apparent stabilisation in US rates, we decided to add a touch more EM exposure in April.
In keeping with our note last month, there has also been a flurry of sustainability-linked issuance in recent weeks from sub-investment grade companies. High yield is not an area renowned for the strength of its ESG credentials, but the sustainability-linked format arguably works better for smaller, including high yield, companies that aren't necessarily big enough to fund dedicated green projects with a green bond. Provided issuers’ intentions are as genuine as they appear when scrutinised by our analysts, we do think that there are some good, higher yielding opportunities appearing for ESG-conscious investors.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. The Fidelity Strategic Bond & Sustainable Strategic Bond Funds Fund can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.