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Investing in fixed income in a rate hiking cycle
Keiyo Hanamura
April 13, 2022
KEY TAKEAWAYS
- For cautious investors looking for downside protection and equity diversification. Investment-grade corporate bonds can provide stability in times of crisis, and their relatively higher income can help to generate modest returns. Capital Group’s Global Corporate strategy has the potential to offer higher returns without taking on significantly increased risk.
- For investors with a longer investment horizon and/or high tolerance for risk. High yielding bonds’ shorter duration reduces the negative impact from rising rates. In addition, their high levels of income can provide equity-like returns over the long-term. Capital Group’s Global High Income Opportunities strategy has a long track record of generating high income while skilfully limiting downside risk1.
- For investors who don’t want to compromise. With the ability to manage duration and credit risks according to market conditions, total return strategies can focus their risk budgets where portfolio managers see the strongest opportunities. Capital Group’s Global Total Return Fixed Income strategy can be considered a core strategy as it aims to deliver the defensiveness of traditional bond strategies, but with the flexibility to generate more attractive returns.
Major central banks have started to tighten monetary policy as they take steps to tackle rampant inflation. Even when interest rates are rising, research indicates that bonds can still deliver positive returns and can continue to offer many benefits. So, what options are available for investors looking to include fixed income as part of a resilient and balanced portfolio?
With major central banks taking steps to tackle inflation, bond yields have already pre-empted a tightening in monetary policy. In the US, Treasury yields in the 10-year part of the curve are well above the levels last seen prior to the pandemic in late 2019, with investors pricing in an aggressive rate hike schedule over the next couple of years. In the eurozone, the 10-year German Bund yield has moved decisively back into positive territory for the first time in three years. Even in Japan, which has long been the bastion of ultra-low interest rates, the yield on the 10-year benchmark bond has reached a six-year high as markets test the upper limit of the Bank of Japan’s yield target. While we are only at the beginning of the new hiking cycle, markets do seem to be experiencing some volatility; however, fixed income assets continue to offer stability in a portfolio and can be particularly beneficial to investors in the current market environment.
To find out more about how investing in fixed income can be beneficial during a rate hiking cycle, read my previous paper here: Investing in fixed income during a hiking cycle
Global corporate bonds
For cautious investors looking for downside protection and equity diversification. Investment-grade corporate bonds tend to be the most aligned with movements in sovereign bonds as they share many key features; long duration, high quality (higher rating), and superior liquidity. Investment-grade corporate bonds can provide stability in times of crisis, as falling sovereign bond yields often outweigh widening in credit spreads (the additional yield offered by corporate bonds over sovereign debt). Moreover, in times of rising rates, this additional yield helps to reduce the impact of capital losses, an important consideration when overall yield levels are low, especially for investors facing potentially higher hedging costs. Additionally, investment-grade corporate bonds can receive support from quantitative easing programmes as they appear to be relatively high on the priority list; in the US, investment grade corporates are next in line after government bonds and mortgage-backed securities.
Capital Group’s Global Corporate strategy offers the potential for higher yields without taking on significantly increased risk. Unlike the majority of corporate bond strategies, this strategy does not allow exposure to high-yield issuers, as we believe it introduces unwanted risks. The strategy’s approach focuses on delivering excess returns through multiple security- and industry-specific decisions, rather than by relying on making significant macro moves – which may be difficult to get right consistently. Taking advantage of the diverse nature of this asset class, the strategy is managed solely by investment grade corporate analysts. This setup allows the strategy to achieve diversification while directly benefiting from analysts’ high conviction trade ideas.
This approach has delivered strong returns, with Capital Group’s Global Corporate strategy often having outpaced its index by more than 1% per annum on a before-fees basis2. The strategy has delivered a return profile close to that of high yield bonds, while limiting risks to levels similar to investment-grade bonds. As a result, investors have been able to enjoy the benefits of high quality assets, such as liquidity and diversification from equities, while also achieving strong returns.
1. Based on the representative account for the strategy, which averaged an income of 7.1% over the last 10 years as at 31 December 2021.
2. Data as at 28 February 2022. Index is Bloomberg Global Aggregate Corporate hedged to USD. Sources: Bloomberg, Capital Group
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