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Audio Commentary

Attractive Starting Point for Multi-Asset Fixed Income

Attractive Starting Point for Multi-Asset Fixed Income

Portfolio Manager Brian Kloss and Senior Vice President – Investment Specialist Katie Klingensmith discuss the current rationale for allocating to global multi-sector fixed income. A summary of their conversation is included below. For the full discussion, listen to the podcast or download the transcript.

Current yields point to a compelling starting point for global fixed income, offering an attractive opportunity set with respect to total return potential. Furthermore, while equities have had a strong showing, their prospective returns may face greater headwinds, especially as valuations generally are considered stretched. Meanwhile, geopolitical risks and other uncertainties remain. These factors lend additional support to the case for fixed income from both a potential diversification and risk management perspective.

How might falling policy rates impact fixed income?

In the short term, we see falling rates as an opportunity. For example, developed market bonds are likely to offer an attractive return opportunity from a total return perspective as rates fall. In addition, credit instruments may begin to have the ability to refinance at lower rates, providing more liquidity into the market. These dynamics also should benefit emerging markets, which have a credit component as well.

Are tight spreads in both high yield and investment grade credit a concern?

While spreads are tight, it is important to consider the other aspect of credit instruments—the yield component. Currently, the starting point with respect to yield is quite compelling. There are concerns that lower-quality credit may struggle in the current environment, but we see an opportunity for credit to add incremental return potential through careful selection and active management.

What sectors or themes present opportunities?

In the very short term, we find shorter-dated maturities from quality companies attractive. That does not necessarily mean by rating, although there likely will be a correlation. Instead, we are looking for those companies with strong management teams and the ability to refinance in this environment—even if we see continued inflationary pressures or a harder economic landing. With respect to sectors, we are intrigued by those that are commodity driven, particularly given the transition in the global economy that is underway. We also believe opportunities may arise from artificial intelligence and the role it is going to play in the global economy as society learns how to harness this technology and increase productivity.

How does the global credit landscape compare to the U.S.?

It is important to remember that the global economy is not always in sync, so having the ability to look globally and take advantage of opportunities around the world, to us, is critical. One important question is what type of recovery will China have? Furthermore, how will that translate into the opportunity set? What is the outlook for Europe after exiting both the pandemic and negative interest rate policy? One of the themes playing out has been a rebalancing of the global supply chain. We think Latin America stands to benefit along with other areas, such as Central and Eastern Europe.

With respect to China, it appears its recovery will be very targeted—with a targeted economic plan—so, we do not expect growth to be as it has in the past. The Chinese authorities have indicated a 5% target for growth, which probably means credit does well. But it may not necessarily translate into a robust credit environment. Europe potentially could be challenged given the significant linkage between Chinese economic growth and European growth. We are finding opportunities in European credit, especially at that front end of the curve and those tied to commodities. But the opportunities are nuanced, and it will be important to understand the differing economic policies and their implications as they unfold.

What are the trends in emerging markets?

Emerging market central banks generally have been robust in their response to inflation, and this disciplined fiscal environment has been attractive. Many of these markets also stand to benefit from increasing demand for both hard and soft commodities as economic growth rebounds globally. Lastly, we have seen management teams remaining disciplined with respect to running their businesses by avoiding too much leverage.

Are there opportunities in securitized credit?

Fundamentally, securitized credit generally remains a strong market, especially in residential mortgage-backed securities. While there may be some pockets of weakness, the residential housing market continues to be supported by a robust labor market and stable house prices. Private or non-agency mortgages offer an attractive yield at this time.

Is there still a case for holding developed market sovereigns, including U.S. Treasuries?

We would argue that there is a case for holding these bonds, both from a multi-sector strategy perspective and from a general risk management point of view, particularly when one considers the risk-off scenarios that could unfold and how to potentially insure against those types of events. Additionally, the historical data around when the Federal Reserve starts to cut rates and how developed market sovereigns perform at that point in time makes an additional argument for a potential total return opportunity.

What could be the biggest drivers behind multi-sector fixed income this year?

One would be the small resurgence in inflation, understanding whether goods and service inflation may be stickier or if these are just anomalies that will not materially impact the Fed’s 2% target. Another risk is around the wars in Ukraine and the Middle East and their impact on growth. The U.S. election also will be pivotal. We expect increased volatility around these events, which supports the case for active portfolio management in our view.

Press play below to listen to the full commentary.

Groupthink is bad, especially at investment management firms. Brandywine Global therefore takes special care to ensure our corporate culture and investment processes support the articulation of diverse viewpoints. This blog is no different. The opinions expressed by our bloggers may sometimes challenge active positioning within one or more of our strategies. Each blogger represents one market view amongst many expressed at Brandywine Global. Although individual opinions will differ, our investment process and macro outlook will remain driven by a team approach.