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Philippe Berthelot, Head of Credit and Money Markets at Ostrum AM, addresses key investor concerns and what they mean for fixed income allocations. Ostrum AM is an affiliate of Natixis Investment Managers and forms part of our «Expert Collective».
The return of inflation, an energy crisis, war. The road for investors has been paved with plenty of challenges over the past 18 months. According to the 8,550 people in 23 countries surveyed by the 2023 Natixis Investment Managers Individual Investors Survey1, the top investment concerns were:
- Inflation (58 percent)
- Recession (38 percent)
- Market Volatility (28 percent)
- Rates (28 percent)
- War (27 percent)
In this Q&A, Philippe Berthelot, Head of Credit and Money Markets at Ostrum Asset Management (Ostrum AM), assesses the relative validity of these concerns and how they might impact investors’ fixed income allocation. Past performance is no guide to future performances. Capital at risk.
Philippe Berthelot, is it still time to consider bonds?
Well, 2022 was an annus horribilis for fixed income – one of the worst years for the asset class in over two decades2. We think 2023 will be remembered as an annus mirabilis for this asset class – a more prosperous year. A typical Investment Grade index in Euro has yielded more than 3 percent since the beginning of the year, as at the end of July 2023.
It amounts to 5.5 percent in Euro High Yield, 3.7 percent in US Investment Grade, and almost 7 percent in US High Yield2. So, the bulk of fixed-income assets have fared quite well. We are still benefitting from historically high yields in credit. It’s something we had not seen for 15 years2.
Investors are concerned about inflation and recession. What’s your view?
Core inflation, that is inflation without the most volatile components such as energy prices and food, has been more persistent than many anticipated. We are expecting headline and core inflation to continue to recede in the next 12-18 months.
Inflation in absolute terms is too high but the trend is going in the right direction, which is good news for bond investors. We have excluded the scenario of recession since Q4 2022 when 80 percent of economists and strategists were in the opposite direction2.
Despite the collapse of US regional banks and the volatility that brought to markets, Ostrum AM fixed income strategies have been able to perform. We may face an economic slowdown in the US and Europe but it won’t be a hard landing. In my view, recession risk has been exaggerated by some strategists, economists and portfolio managers.
What about market volatility?
Market volatility is not an issue for equities. When you look at investors’ sentiment through the VIX or the V2X – which is implied equity volatility respectively in the US and in Europe – they are still at abnormally low levels, below 15 percent2.
And we are nearing the end of the hiking cycle on the two sides of the Atlantic. However, rate volatility is very high compared to equity volatility. It should normalize. Low volatility in equity markets and high level of profit margins have been a support for the bull market in equities since the beginning of the year.
Firms have been able to transmit the rise in production cost to the final consumer price.
Does your view of portfolio construction change if one of these risks takes priority?
Since the pandemic, the environment has been quite challenging. Every portfolio manager, either in fixed income or equity, has become a bit more humble. It’s understandable given we have faced so many black swans and unprecedented events. Now we need to remain nimble.
Over the past two years, we have been very active in monitoring and changing the rate duration of our credit portfolios because it has been a source of performance, accounting for 30 percent of our alpha generation last year2. When central banks are hiking rates, you have considerably more volatility in rates compared to the last 20 years.
This is something you need to be careful of because rate volatility is a risk for bond portfolios. Two years ago, we saw negative yields – or certainly close to zero yields. The Investment Grade Index was not at 4.5 percent but at 0.5 percent.
One-third of the Investment Grade Index was posting negative yields, which are not very appealing for most investors. This period is now over. Fixed income is back. Some asset allocators are reconsidering the asset class and have switched to it from equities.
Last February, for the first time in the past decade, the equity dividend yield was below the Investment Grade yield.
Would you agree with the statement that investors worry about rates, but most don’t know why?
The Natixis survey found that 57 percent of investors say they understand what happens to bonds when rates increase1. In reality, only 2 percent could provide the correct answers to a question relating to the impact of rising rates on bonds1. There’s no getting away from the fact that understanding bonds is demanding.
You need to understand, for instance, what a yield, an income, a duration, or a carried interest is. People tend to mix up total return and yield, which are different things. Likewise, there’s confusion around maturity and holding periods. To simplify, if you are after a regular income with fewer risks than equities, you should consider fixed income.
If you can invest on your own in equities, it seems more complicated for an individual to invest on their own in bonds. In our opinion, the simplest way to get access to the fixed-income asset class is to invest in mutual funds managed by professionals.
A solution might be to invest in hold-to-maturity strategies with a specific maturity date and a given yield.
Ostrum AM is an affiliate of Natixis Investment Managers and forms part of our Expert Collective.
1Source: Natixis Investment Managers, Global Survey of Individual Investors conducted by CoreData Research in March and April 2023. The survey included 8,550 individual investors in 23 countries.
2Source: Ostrum AM, September 2023.
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