Recent rises in inflation -- to levels not seen in decades -- have negatively affected returns across most asset classes. Rate rises have been some of the steepest seen in many decades. In the current environment, as we move further into resolute central bank tightening, we may see a considerable cooling down in global economies. With yields at levels not seen in 10 years and risks of macroeconomic slowdown on the horizon, now could prove to be a very attractive entry point into global sovereign debt.
Why INVEST IN long-duration sovereign bonds IN THIS MARKET?
In anticipation of a disinflationary environment with slowing (or even negative) growth, sovereign bonds can offer concentrated exposure to upside in macroeconomic environments which are less favourable to most other asset classes. Economic slowdowns tend to be accompanied by a fall and a flattening of the yield curve, while equities and credit suffer: historically, sovereign debt is the most effective hedge against recessions.
With market participants no longer accustomed to inflation and interest rate levels where they are now, we have witnessed a major sell-off in bond markets. The uncertainty that many investors felt going into 2022 around the post-Covid recovery and inflationary risks has been exacerbated by the war in Ukraine, leading to even greater apprehension in parts of the market.
Sovereign debt yields have moved sharply higher following the recent sell-off. While very painful for existing investors, this re-set in the bond market has restored valuations to levels that we think make this an attractive asset class in its own right, particularly in an economic slowdown.
YTM - JP Morgan GBI Global Index - January 2012 to June 2022
Source: Bloomberg©, as at 21/06/2022.
How can investors benefit from AN actively-managed RATES PORTFOLIO?
Index-tracking vehicles can appear to be a simple, low-cost strategy to add exposure to rates. In our view, however, this can be a missed opportunity to unlock the potential offered by this asset class. The Candriam Bonds Global Government Fund makes active decisions to exploit multiple, uncorrelated sources of alpha where we think they exist.
- Duration: Yield curves not only rise and fall, but can also steepen, flatten or twist. Many investors face constraints prohibiting them from deviating significantly from a given duration in their portfolios, which can lead to some points on the curve being undervalued compared to others. We seek these out and look to position the fund at the most attractive tenors. Our flexible approach allows active duration in a range of -3 to +3 against the benchmark.
- Relative Value and ESG: With national treasuries no longer able to refinance maturing debt at ever-lower rates, issuer-specific dynamics are again coming to the forefront. In bond indices, issuers are weighted by the total amount they owe to borrowers – which can inherently bias them towards countries with less sustainable debt profiles. Notably, we believe that ESG factors are, in addition to other traditional financial and economic variables, a key determinant in a country’s creditworthiness. Our proprietary Sovereign Sustainability Framework is based on the analysis of four forms of capital: Natural Capital, Human Capital, Social Capital and Economic Capital.
- Currencies: Economies do not typically move through monetary and growth cycles in lockstep. Exchange rates can be impacted as some central banks act more decisively than others. We look to identify which currencies and yield curves are most attractive. Unlike an index fund, we are not constrained by the weights of currencies in the benchmark, and can use derivative overlays to express our convictions.