The wild swings seen in fixed income as investors grapple with stubbornly high inflation, further rate hikes and a potential recession underline just how brittle confidence remains.

The return of bonds as a viable diversifier had been loudly proclaimed by asset managers since the tail end of 2022 through January, when markets rallied sharply. But after the selloff during the past two months, sparked by changing expectations on monetary policy and fears of a banking crisis, caution is once more the watchword.

‘We have adopted a defensive investment stance for the next six to 12 months as the economic cycle in the US and Europe peaks,’ said Steve Brice, chief investment officer at Standard Chartered Bank.

The Asian lender has been increasingly bearish on the economic outlook, with Brice consistently warning about the risks of a US recession.

He believes the weakness in the American regional banking sector following the collapse of Silicon Valley Bank (SVB) could prove to be a harbinger of the downturn, forcing the Federal Reserve to pivot and cut rates before the year end.    

Amid the uncertainty, Standard Chartered moved overweight developed market government bonds and US dollar-denominated Asian bonds, where spreads have widened after Treasury yields fell, in early April.

‘The Asian US dollar corporate bond market is overwhelmingly investment grade, which helps in an environment where the US and Europe face elevated risks of a recession,’ Brice said.

‘These bonds are also likely to benefit from an expected upturn in corporate earnings in Asia on the back of China’s reopening. China’s economy is at the opposite end of the spectrum versus the US and Europe – economic growth in China is expected to accelerate to more than 5% this year, helping repair and strengthen regional corporate balance sheets.

‘This upturn is likely to filter through to Asian USD bond prices.’

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‘We have adopted a defensive investment stance for the next six to 12 months as the economic cycle in the US and Europe peaks’

^{Steve Brice, Standard Chartered Bank}

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Quality control

Brice recommends investors sit in higher-quality-yielding assets to ride out any future shocks as the macro-storm clouds gather. For all the ructions in the market since the turn of the year, a buy-and-hold strategy would have delivered solid if unspectacular gains in the first quarter. Global investment grade, US Treasuries and high yield all delivered about 2.5% in total return terms, according to Bank of America data.

Many expect a divergence through the rest of the year, however, and the focus on ‘quality’ is a major theme in asset managers’ second-quarter outlooks. The word peppers market commentaries, and HSBC Asset Management head of Asian fixed income Elizabeth Allen expects this to continue, at least in the near term.

‘While we have expected to see market volatility in the first half of 2023, the movement, especially in the US rates market, has been particularly drastic,’ she said. ‘We have been maintaining a quality bias in our portfolios generally and also watching our exposure very closely so as not to take excessive risk during a period of high volatility.’

At a sector level, HSBC AM has been favouring consumer names benefiting from the reopening of Greater China. It has also been backing long-term structural growth plays in India and Indonesia, including companies tapping into the green energy theme.

Allen said she had been able to pick up some ‘selected quality bonds at attractive valuations’ during the selloff. She is wary of bank debt after the collapse of SVB and the Swiss National Bank’s controversial decision to wipe out $17bn of Credit Suisse AT1 bonds as part of its forced marriage with UBS.

‘With the US and European banks at the centre of the storm, their Asian counterparts are subject to a different set of macro, regulatory and monetary conditions,’ Allen said. ‘[We] focus our investments on the stronger banks and bonds with stronger protection.’

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‘We think the BB market offers a sweet spot for corporate bond fund managers, where they can capture some of the yield from non-investment grade debt without taking exposure to as many “blow-ups”’

^{Peter Harvey, Schroders}

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Casting the net wider

Some investors are moving further down the credit spectrum, with Schroders arrowing in on so-called crossover bonds to scoop up chunkier yields. Sitting in the borderlands of investment grade and high-yield, these bonds, mainly BB rated, are underresearched, according to Peter Harvey, a credit portfolio manager at the British fund house.

‘We think the BB market offers a sweet spot for corporate bond fund managers, where they can capture some of the yield from non-investment grade debt without taking exposure to as many “blow-ups”,’ he said.

Harvey points to yields north of 7%, with a long-term average default rate of 1% and a broad mix of sectors and investments. These range from fallen angels to leveraged buyouts and subordinated financials, spread across the whole gamut of industries.

Standard Chartered is cautious on dipping into high-yield though, being underweight both US and Asian high yield on concerns about slowing global growth and rising refinancing costs.