Taking a line from the iconic spy thriller series, fund selectors are saying: ‘The name’s Bond’. Of course, not James, but high-grade bonds.
After a historically bad year in 2022, fixed income has rallied strongly in 2023. Despite an environment of steadily rising interest rates and inflationary concerns, bonds are once again on the radar of investors as they continue to offer attractive yields, although the recent US banking crisis has taken a little of the sheen off them.
According to data from Bloomberg, the yield on the 10-year Treasury note is hovering in the vicinity of 3.5% after the Federal Reserve announced yet another 25-basis-point rate hike in March. Investors also have opportunities in short-duration fixed income, with six-month and two-year Treasuries yielding 4.76% and 4.1% respectively.
‘Longer-duration quality bonds in US dollars for a part of the fixed income allocation look attractive, helping to mitigate reinvestment risk,’ said Rishabh Saksena, head, investment specialists Apac, Julius Baer.
Echoing a similar sentiment, UBS Global Wealth Management’s (UBS GWM) Jansen Phee, head of fund investment solutions Apac and head of global investment management China, said: ‘High-grade and investment grade bonds remain attractive as defensive assets.’
‘Longer-duration quality bonds in US dollars for a part of the fixed income allocation look attractive, helping to mitigate reinvestment risk’
Rishabh Saksena, Julius Baer
Rate-hike cycle ending
When making its ninth hike since March 2022, the Federal Reserve Board’s rate-setting open market committee noted in its most recent announcement that future interest rate increases were not certain and would depend largely on incoming data.
Many fund selectors spoken to by Citywire Asia believe the Fed will stop cutting interest rates before the year-end and yields will start falling.
RBC Wealth Management said it believed the Fed’s rate hike in the third week of March would ‘be either the last or second to last one of this rate-hike cycle’.
Ken Peng, head of Asia investment strategy at Citi Global Wealth Investments, said: ‘We expect the US Federal Reserve to end its rate hikes by May, and 10-year US Treasury yields may fall below 3% before the end of this year.’
And in its April outlook, Standard Chartered Wealth Management said it expects the 10-year US government bond yield to fall to 3.25-3.5% by end-June and 2.75-3% by year-end, so it is raising exposure to high-quality government bonds.
‘We expect the US Federal Reserve to end its rate hikes by May, and 10-year US Treasury yields may fall below 3% before the end of this year’
Ken Peng, Citi Global Wealth Investments
Selective and defensive
So what are Asian private bank clients looking for in fixed income allocations?
Peng said fixed income was viewed both as a flight to safety and as an opportunity to lock in income for wealthy clients. ‘But for the next three to six months, it’s important to stay very high quality as credit risk may rise further while risk-free rates fall,’ he said.
The recent increase in US Treasury yields enabled meaningful returns in the fixed income market, said Julius Baer’s Saksena. ‘While one could argue prevailing higher inflation implies lower real yields, the impact of aggressive monetary tightening on aggregate demand should help moderate inflation going forward,’ he said. ‘This backdrop provides a good opportunity for Asian clients.’
Phee said that aside from adding carry yield to a portfolio, fixed income as an asset class offered stability in times of economic uncertainty and the potential to generate higher total returns in a recession scenario, where anticipated rate cuts would lead to a drop in bond yields and an increase in bond prices.
However, there are still risks to increasing exposure to fixed income. There may be a deterioration in credit quality of bond exposures in case of a recession, for example, and higher interest rates if inflation turns out to be stickier than expected. ‘Credit risk is likely to rise during a recession,’ Peng warned.
Saksena said that dollar-denominated longer-duration quality bonds could be complemented by select lower-quality investment grade bonds of shorter duration.
‘Fixed income as an asset class offered stability in times of economic uncertainty and the potential to generate higher total returns in a recession scenario’
Jansen Phee, UBS Global Wealth Management
China property bonds
In January this year, bonds issued by China’s real estate developers rebounded sharply after the government offered an industry rescue package and reopened the economy and borders swiftly. This seemed to have kindled some bargain-hunting among investors.
There had been positive signals suggesting ample availability of mortgage loan disbursement, said UBS GWM’s Phee. Housing data in the early months of 2023 also showed a recovery in the physical transaction side.
‘However, recent earnings results from Chinese property developers and property management firms have been weak and largely below expectation. Therefore, we remain selective on investment grade bonds while remaining cautious on lower-rated bonds,’ he said.
Peng believes that as more defaulted issuers restructure, the market should become more stable. ‘The rebound in property sales is relatively strong and should serve as a support for the sector. But the opportunity is likely only cyclical, whereas the long-term prospect for the sector remains challenging.’
