Fixed income yields sitting at attractive entry point

Abrdn’s head of global fixed income, Jonathan Mondillo, has outlined a favourable environment ahead for bond investors, describing a “far more encouraging” backdrop today than recent history.

However, he cautions a more selective investment approach might be necessary to navigate any lingering risks in the market, particularly stemming from the incoming Trump administration.

“Fixed income yields are relatively high compared to the past few years, offering an attractive entry point into the asset class. We therefore expect positive total returns, driven by the attractive carry and a tailwind of falling interest rates,” he said.

He forecasts robust corporate profitability to continue, which has been one of the factors compressing credit spreads across investment-grade (IG) and high-yield (HY) bonds, which have tightened below their respective long-term averages. 

“Corporate fundamentals remain resilient, with leverage and interest coverage ratios at comfortable levels, indicating investors are being adequately compensated for taking on credit risk. This view is also supported by credit agencies, which are forecasting a relatively benign default environment,” he said.

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“However, we are more cautious on the lower-rated HY bonds and are very selective regarding exposure to these names.”

Mondillo highlighted there is over US$6 trillion currently sitting on the sidelines of the investment world, with fixed income emerging a “compelling destination” for much of this capital. 

Interest rates are projected to trend lower, which will be supportive of bond returns, he pointed out. Additionally, global inflation seems largely under control and abrdn is not forecasting any “widespread recessions” as economies cool.

Still, “while we don’t expect large-scale defaults, careful selection to avoid underperforming securities and industries will remain crucial,” he said.

Elaborating on this, Mondillo highlighted that a combination of BBB (the lowest IG rating) and BB (the highest HY rating) bonds has been found to offer the best risk-adjusted outcomes over the long-term. 

“This can be captured in a global income bond strategy. Investors who concentrate on strategies managed against traditional credit benchmarks often overlook and underappreciate this section of the market,” he said. 

“Structurally, a global approach can provide unique benefits, such as high yield-like returns, with investment grade-type risk.

“When combined with disciplined bottom-up credit research, global income bonds can be an attractive option for delivering client outcomes.”