Global Insights

A new era of uncertainty presents opportunities for active bond investors

It has been a painful year to date for investors in fixed income. The abrupt sell-off means investors can now find some compelling valuations. But careful analysis is key to understanding which investments stack up from a risk/reward perspective.

17 Jun 2022

4 minutes

Werner Gey van Pittius
Victoria Harling

The fast view

A significant repricing has taken place in fixed income markets

  • Since the start of the year, bond markets have faced a double whammy of rising yields (from the sell-off in government bonds) and widening credit spreads (from reduced risk appetite). We’re in a bond bear market.
  • Monetary policy is a key driver of this shift: most central banks have begun to increase interest rates to tackle inflation and are retreating from bond markets, having been major buyers in recent years. War in Ukraine has further weighed on risk appetite and increased inflationary pressure.
  • However, the EM risk premium has held firm, reflecting fundamental strength in many EM economies. It’s US dollar and US Treasury market moves that have driven weak EM debt market returns, with rate hiking in EMs also a factor as their central banks moved decisively to tackle inflation.

We’ve reached attractive entry points in various markets

  • Just as they did during the COVID sell-off, higher-quality segments of the global credit market have underperformed, creating some attractive opportunities.
  • Not least because of the ‘postcode premium’ – whereby negative country-level headlines drive corporate bond yields disproportionately higher – today’s yields in the EM corporate credit market point to historically attractive valuations across the board.
  • Similarly, yields in parts of the EM sovereign debt market are at post-Global Financial Crisis highs. But the more challenging global backdrop warrants a selective approach to investing.

Navigating uncertainty means focusing on fundamentals and avoiding generalisations

  • It’s unclear how much interest rates will need to rise and how well economies will withstand rate hikes. And while Russia and Ukraine are only small parts of the bond universe, sanctions risk remains a key consideration. All of this requires careful navigation.
  • Weaker global growth may increase the likelihood of defaults, but investors should note that:
    • While China’s zero-COVID policy remains a drag on growth, the country’s authorities have been able to loosen monetary policy (thanks to benign inflation) and announce supportive measures in the property market. But the timing is uncertain and investors need to be both patient and vigilant.
    • The most vulnerable EM countries account for a small proportion of the overall market and the current level of bond yields in these markets means investors are well compensated for the risk.
    • Current market prices don’t accurately reflect the fundamental strength of many EM economies or the support and involvement of the IMF.
    • In the corporate bond market, most defaults have been in China’s real-estate sector. Elsewhere, it’s vital to assess how robust individual companies are, as there will be winners and losers in all market segments.
    • In aggregate, EM companies are fundamentally strong and well placed to withstand headwinds. In recent years, they have pared back their expansion and capital expenditure, leaving them with healthy cash balances and strong buffers.

Opportunities abound

  • In our Multi-Asset Credit strategy, we are selling some high-yield exposure and buying into higher-quality market segments that have recently underperformed. We also like defensive investments such as short-duration credit. We think these areas offer a good balance of potential upside if markets improve and downside protection should volatility remain high.
  • In EM sovereign debt markets, we see compelling opportunities in some high-yield markets where default risk is we believe overestimated; long-dated investment-grade debt issued by some Gulf Cooperation Council countries is also trading at levels that we do not feel reflect fundamentals.
  • In local currency bond markets, by hiking rates early EM central banks created both attractive yield entry points and a supportive environment for EM currencies. This, coupled with strong commodity prices, should attract flows to the asset class.
  • There is a wide array of opportunities in today’s EM corporate credit markets across the credit rating spectrum, given the recent sell-off. We are cherry-picking opportunities in all areas of the market. Turmoil in China’s real-estate sector has also created extremely low valuations in some high-quality firms that we think should benefit significantly from positive policy shifts.

EM bond markets are now at the heart of some key global trends

  • The surge in commodity prices is widening the gap between commodity exporters and importers, with some emerging markets benefitting significantly. Furthermore, an increased focus on energy security is likely to boost a range of EM energy exporters, as well as exporters of materials needed for electrification, for example.
  • Heightened geopolitical risk is expected to result in ‘friend-shoring’ of supply chains. This refers to the growing preference to do business with nations with shared values and strategic interests, and is likely to benefit a number of EM economies.
  • Perhaps the biggest shift will be the global transition to net zero. Emerging markets will be at the heart of this, as we outlined here, and we believe bond investors will play a key role in providing the vast amounts of money needed for the world to decarbonise.

All investments carry the risk of capital loss

Specific Risks
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. Government securities exposure: The Fund may invest more than 35% of its assets in securities issued or guaranteed by a permitted sovereign entity, as defined in the definitions section of the Fund’s prospectus.

General risks
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.

Authored by

Werner Gey van Pittius
Portfolio Manager
Victoria Harling
Portfolio Manager

Important Information

This communication is provided for general information only should not be construed as advice.

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Ninety One.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

All rights reserved. Issued by Ninety One.

For further information on indices, fund ratings, yields, targeted or projected performance returns, back-tested results, model return results, hypothetical performance returns, the investment team, our investment process, and specific portfolio names, please click here.