Fixed income evolution over the last 5 years

Over the past half-decade, the landscape of fixed income investing has undergone a remarkable transformation. From traditional bonds to innovative securities, the realm of fixed income has evolved in response to shifting market dynamics, technological advancements, and global economic challenges. In this article, we delve into the key developments and trends that have shaped the journey of fixed income investments over the last five years, offering insights into the opportunities and challenges that lie ahead for investors in this ever-changing landscape

History may not repeat itself but provides a solid basis for investment decisions

Mary-Thérèse Barton, CFA, fixed income chief investment officer in Pictet AM

During the long years of central banks’ quantitative easing and official zero interest rate policies investors grew used to a lack of yield and dispersion across fixed income. So passive index products became increasingly attractive to reduce costs. But investors are catching a shift from the post-global financial crisis. Bond yields are higher than for many years and investors no longer need to seek quality stocks to generate return. Bond and credit markets can again be relied for significant income and buffer against volatility. Also, there is scope for capital appreciation.

During 2023, a barbell approach worked well, with substantial positions in money market instruments at highest low-risk yields for decades and allocating risk budgets on illiquid high-return instruments, like private credit. But returns from emerging markets debt were stifled by swings in developed markets yields and disappointment with China’s recovery.

Whilst there have been some concerns on accelerating inflation, it likely has peaked and official rates peaked, with attractive opportunities across the risk spectrum: sovereign, credit, emerging and private markets. But an uncertain and slow rate cuts pace and relatively high terminal rates are likely to trigger significant volatility and dispersion and a careful active approach to generate high single digit returns from bond and credit for years to come.

Significant volatility and dispersion

In fact, a lower inflation and slowing growth environment, at least in developed countries, suggest investors are best served holding US Treasuries and investment grade credit. At the same time, higher rates for longer suggest some caution in high yield, where spreads remain tight and risk of default rise -here focusing on dispersion and credit selection are key-.

On the other hand, local currency emerging debt is supported by stronger national economies and should benefit from a weaker dollar and stronger economies. EM central banks have been quicker and more aggressive in grappling post-pandemic inflationary pressures, loosening monetary policies and succeeding in boosting growth, while outlook for developed countries has been weakening. Emerging market bonds are poised to be a source of excess returns over coming years as volatility within safest sovereign bonds dispels the notion that developed equals stability while emerging volatility.  Even Southeast Asia economies have matured, with domestic demand an ever-bigger growth engine.

Over time, inflation is likely to fall within central banks' targets -albeit at a slower pace than anticipated- and prompt rates cuts. This will stimulate growth and restore prosperity. Investors will be governed by a different regime. History may not repeat exactly but will again provide a solid basis for investment decisions.

Unique opportunity to lock in today's yield level

Robert Ryan, Fixed Income Portfolio Manager at BlacRock

In terms of evolutions within the Fixed Income market, the two most notable are:

• Fixed Income yields are near decade highs and furthermore front-end yields provide a unique opportunity for investors to lock in today’s yield level with limited interest rate risk (duration).
• In our view volatility will remain elevated creating more dispersion across credit markets which warrants an approach that focuses on bottom up security selection.  We think the combination of historically high yields and great dispersion create a compelling opportunity for fixed income investors and we have designed the BGF Euro Investment Grade Fixed Maturity Fund 2027 as a way to access of these dynamics.