The new regime for fixed income markets in 2023

High yield could be seen as a relatively lower risk option on an eventual recovery ahead of equity returns, according a top investment executive.

Chris Iggo, chief investment officer for core investments and chair of the AXA IM Investment Institute, outlined how fixed income investors stood to benefit most from the peak in inflation and policy rates.

“For bond markets, the trade-off between return and risk has improved. Yields are higher – compared to the situation in recent years – and this provides more ‘carry’ for bond holders and better income opportunities for new fixed income investments,” he elaborated.

“At the same time, with higher yields, fixed income has the potential to play a more significant role in multi-asset portfolios. In 2022, very unusually, both bond and equity returns were very negative. Thankfully, central banks don’t raise rates by 300-500 basis points every year.

“If equities struggle with the growth environment, bonds can provide a hedge and an alternative to those investors putting a premium on income.”

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For investors, such defensive credit sectors could offer attractive yields in 2023. While returns were dominated in recent years by capital gains as central banks pushed down yields, fixed income should be a more significant contributor to total returns.

Iggo added: “This has portfolio construction implications with bonds now more suited to income-focused strategies as well as allowing institutional investors more flexibility in meeting liabilities without taking unnecessary credit or liquidity risks to achieve yield targets.”

Now more than ever, higher yields could be achieved with less credit risk and duration in an environment where global tightening forced a revaluation across asset classes.

“Yields have been at levels in 2022 that historically have been associated with subsequent positive returns. High yield markets are of better credit quality in general than in the past and have seen similar improvements in credit metrics as the investment grade market.

“Given the close relationship between the excess returns of high yield bonds (relative to government bonds) and equity returns, we see high yield as a relatively lower risk option on an eventual recovery in equity returns,” he said.

While earnings forecasts were expected to be cut further but valuations to become more attractive, he maintained a balanced outlook for the months ahead.

“Cashflow expectations have been challenged and investors should be less confident about capital growth strategies as we enter 2023. Bond returns should improve relative to volatility and parts of the equity market are becoming cheap.

High yield could be seen as a relatively lower risk option on an eventual recovery ahead of equity returns, according a top investment executive.

Chris Iggo, chief investment officer for core investments and chair of the AXA IM Investment Institute, outlined how fixed income investors stood to benefit most from the peak in inflation and policy rates.

“For bond markets, the trade-off between return and risk has improved. Yields are higher – compared to the situation in recent years – and this provides more ‘carry’ for bond holders and better income opportunities for new fixed income investments,” he elaborated.

“At the same time, with higher yields, fixed income has the potential to play a more significant role in multi-asset portfolios. In 2022, very unusually, both bond and equity returns were very negative. Thankfully, central banks don’t raise rates by 300-500 basis points every year.

“If equities struggle with the growth environment, bonds can provide a hedge and an alternative to those investors putting a premium on income.”

For investors, such defensive credit sectors could offer attractive yields in 2023. While returns were dominated in recent years by capital gains as central banks pushed down yields, fixed income should be a more significant contributor to total returns.

Iggo added: “This has portfolio construction implications with bonds now more suited to income-focused strategies as well as allowing institutional investors more flexibility in meeting liabilities without taking unnecessary credit or liquidity risks to achieve yield targets.”

Now more than ever, higher yields could be achieved with less credit risk and duration in an environment where global tightening forced a revaluation across asset classes.

“Yields have been at levels in 2022 that historically have been associated with subsequent positive returns. High yield markets are of better credit quality in general than in the past and have seen similar improvements in credit metrics as the investment grade market.

“Given the close relationship between the excess returns of high yield bonds (relative to government bonds) and equity returns, we see high yield as a relatively lower risk option on an eventual recovery in equity returns,” he said.

While earnings forecasts were expected to be cut further but valuations to become more attractive, he maintained a balanced outlook for the months ahead.

“Cashflow expectations have been challenged and investors should be less confident about capital growth strategies as we enter 2023. Bond returns should improve relative to volatility and parts of the equity market are becoming cheap."