- Fixed Income Portfolio Manager
Hong Kong (香港), Individual
Change
The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed.
Despite looming (and growing) economic recession risks, we see several potential opportunities in higher-yielding credit sectors (as shown in below chart). While these excess return forecasts assume that spreads will revert to their historical medians, our slightly more bearish forecast incorporates some degree of spread widening given our expectation for an economic slowdown. In our view, some of the most compelling opportunities in fixed income credit sectors include:
- Additional Tier 1 European banks (AT1s/CoCos): Banks for which the trajectory of fundamentals remains positive and are trading below par, offer the potential for price appreciation if called by the issuer.
- Credit risk transfer (CRT) bonds: These securities continue to be supported by strong housing data releases and a favorable technical backdrop: Supply remains limited while investor flows have been positive.
- Agency mortgage-backed securities (MBS): Spreads on MBS have widened on the back of elevated rate volatility. MBS excess returns also tend to be less correlated with credit risk and hence add some diversification to credit portfolios.
- High-yield derivatives: Within high yield, one of our highest conviction ideas is the price differential between high-yield credit default swaps (CDX) and their underlying cash bonds. Compared to history, high-yield CDX offers an attractive relative spread advantage to cash.
Conversely, emerging markets (EM) USD-denominated sovereign spreads remain in the tightest quintile relative to history. As a result, we think it is prudent to consider reducing EM sovereign exposure in favor of the opportunities outlined above.
Figure 1
Looking ahead, we believe that bouts of volatility in 2024 could generate greater idiosyncratic dispersion and create better entry points to add credit exposure. Despite economic and monetary policy uncertainty, we believe the potential upside from earning today’s historically high yields and being ready to take advantage of credit market dislocations as they arise outweigh the possible risk from rates moving higher. In our view, various dislocations in higher-yielding credit markets could offer the most compelling opportunities for asset owners in 2024, with a goal of pursuing yield and total return in a manner that is as efficient and risk-controlled as possible. We also think it is important for investors to stay flexible and nimble in an uncertain market landscape.
