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Insurance investment teams could see a rethinking of fixed income strategy given yields rising and global bonds outperforming US bonds in 2023.
It’s been a rollercoaster of a year for fixed income – with current bond sell offs still ongoing – and many are wondering what 2024 will bring for markets.
“Investors need to be very thoughtful about which countries to own and where duration is held,” said an analysis from Franklin Templeton in conjunction with Western Asset. “The most effective way to accomplish this – while at the same time trying to navigate volatility – is by embracing an active approach to global bond investing.
Investors should capitalise on market dislocations, it added.
Insurance investment teams need steady cashflows to match long-dated liabilities, and the search for stable, reliable yield is always top of mind. However, anxieties around inflation worldwide and US political instability are continuing to spook markets.
With that said, a reconsideration of global bond allocation might be in order.
Currently, non-US bonds account for around 57% of the world’s bond market – with the Bloomberg US Aggregate index trailing the Bloomberg Global Aggregate index over the past 30 years.
“In periods of extended USD weakness, non-US assets have tended to perform well.”
Global bonds’ strong performance comes with US interest rates rising faster than those in other parts of the world – currently at 5.25 to 5.5%. As the Franklin Templeton and Western Asset report said, it was “important to factor in” the direction of the US dollar (USD).
“Last year, the USD surged higher mostly on the back of the Fed’s aggressive rate-hiking campaign. Since [its] peak last September, improving global growth prospects and a narrowing interest-rate differential have pushed the USD lower,” it said.
For insurance investment teams, especially those heavily invested in US bonds, global fixed income can help mitigate exposure to US-specific risk.
On future predictions for global markets more broadly, the report added that “in periods of extended USD weakness, non-US assets have tended to perform well”. On the other hand, “US bond markets appear to have foreseen an imminent end to Fed tightening”, the report said. “We think long yields have risen enough in the face of the new realities, but time will tell.”
Global bonds, it continued, offered compelling yield alongside risk and diversification benefits – which investment teams would be wise to consider.
In the UK, the picture looks a bit different – with the Franklin Templeton and Western Asset report saying that it believed the market “expected too much” in terms of rate hikes from the Bank of England (BoE).
“Gilts should outperform,” it added.
“It is increasing likely that BoE is at the end of their rate increase agenda
especially given our view that a recession is on the horizon.”
These sentiments came before the BoE held rates at 5.25% in September. However, many now – though not all – are expecting another hike before the end of the year.
“If one is looking for a positive on [September’s] hike, it is increasing likely that BoE is at the end of their rate increase agenda especially given our view that a recession is on the horizon,” said Nate Thooft, Chief Investment Officer and Senior Portfolio Manager at Manulife Investment Management.
At the Morningstar Investment Conference UK, in July, Iain Stealey, International Chief Investment Officer, Global Fixed Income, JP Morgan Asset Management, said that a turbulent macroeconomic environment plagued by tightening monetary policy throughout the West means that diversification is key when it comes to fixed income allocation.
“It’s the best time to be speaking about fixed income in 15 years,” he said, advocating for private credit and cautioning about selecting ‘green’ bonds without proper due diligence – infrastructure bonds such as municipals included.
However, his main message was that a globally diversified fixed income portfolio that capitalised on both shorter- and longer-term would be beneficial to all investors during this period.
In the EU – where European Central Bank (ECB) rates are remaining higher for longer – the September rise of 25 basis points saw Eurozone rates the highest they’ve ever been, worrying some investors.
“From here the focus will be on the extent of the growth weakness and how
this will contribute to a further decline in inflation.”
Others, however, are more optimistic. Steve Ryder, Senior Portfolio Manager at Aviva Investors, said that September’s “finely balanced ECB meeting” moved the central bank into an “on-hold camp for the foreseeable future”.
“From here the focus will be on the extent of the growth weakness and how this will contribute to a further decline in inflation. We thought a hawkish hike was unlikely today and so agree with the price action which is focused on the end of the tightening cycle,” he added.
“We believe that the ECB runs the risk of tightening policy by too much,” said Franklin Templeton and Western Asset’s report. “Weaker growth and falling inflation should allow the ECB to stop hiking in H2, which will support euro area bond yields.”
Many were singing the praises of global bonds – especially due to their return potential.
Nigel Jenkins, Managing Director at global asset manager Payden & Rygel, said that he was anticipating “cash-like” returns on global bonds for 2023.
“Inflation-protected bonds, including TIPs, are a pocket of value, especially
for anyone concerned about the risks of higher inflation.”
Returns could become higher if global growth weakened, or lower if inflation picked up again, he added. “It's a much better year than last year and cash rates are higher. We could see stronger returns later in the year,” he continued.
Discussing the impact of the wider macroeconomic picture, Jenkins said that “looking at the global aggregate index, for example, a global investment grade benchmark that’s hedged back to dollars, it is a little bit behind cash to this point. It wouldn’t be surprising if it caught up and gave modestly cash-plus returns over the whole year.”
He said his strategy at the moment favoured government bonds to a “greater extent than is typical”. This was because credit-risk-free Treasuries (T-bonds) offered about 80% of the average corporate bond yield. “Inflation-protected bonds, including TIPs, are a pocket of value, especially for anyone concerned about the risks of higher inflation,” he added.
The main benefit of global bonds for insurance investment teams is typically diversification – and risk mitigation. “We expect about the same return from a global bond portfolio [compared to a US bond portfolio], with only about 75% of the volatility,” said Jenkins.
“There have been 10-year periods in the past where bonds have outperformed equities. We haven't seen one for some time, but maybe we will over the next 10 plus years. These are very deep, generally very liquid markets with decent return potential.”
“We expect about the same return from a global bond portfolio,
with only about 75% of the volatility.”
In an analysis from this summer, PIMCO agreed with these sentiments. “As we head into and environment of greater uncertainty, global fixed income can be a strong anchor in multi-asset portfolios,” it said.
For insurance investment teams, this is because global bonds increasingly mitigate against country-specific risks.
When faced with high-tension political scenarios in leading bond markets like the US’s, investors may look in other directions – opting to reassess US or UK allocation given political upheaval and higher-for-longer interest rates.
