The damaging combination of rising government bond yields and widening credit spreads made for a very tough quarter for fixed income investors – one of the weakest since the Global Financial Crisis.
Despite falling back in late June as investors’ focus shifted from rising inflation and interest rates to the weaker outlook for growth, the yield on 5-year US Treasuries finished the quarter 57bps higher at 3.04%. Meanwhile, high-yield credit spreads widened by 220bps in the US market and 227bps in Europe, bringing valuations to levels only seen in periods of extreme macro and market structure distress.
Investment-grade (IG) bonds sold off with the rest of the credit market but held up better than high-yield debt as investors flocked to safety. So, while Q1 2022 was characterised by higher-quality parts of the market underperforming as investors shunned duration risk, growth-related concerns saw lower-rated credit underperform in Q2; and after showing impressive resilience in Q1, some of the loan market’s year-to-date outperformance began to unwind in Q2 as the risk-off contagion spread.
Spreads are now wider than long-term averages across all large credit markets and valuations are particularly cheap from a yield standpoint, given the move in underlying government bond yields.
Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Liquidity: There may be insufficient buyers or sellers of particular investments giving rise to delays in trading and being able to make settlements, and/or large fluctuations in value. This may lead to larger financial losses than might be anticipated. Loans: The specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. Many loans are not actively traded, which may impair the ability of the Portfolio to realise full value in the event of the need to liquidate such assets.
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.