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We are pleased to share the key takeaways from our webinar titled 'Is 2023 the Year for Fixed Income.' This insightful session featured a distinguished panel of industry experts, comprising:
These experts shared their perspectives and insights if 2023 will be the year of fixed income.Through engaging discussions, the speakers provided a comprehensive overview of the current market situation and the latest trends in the region. This blog post serves to share the key takeaways from the webinar and offer a glimpse into 2023’s outlook, especially on fixed income. We hope this post will be informative and valuable to all those interested in this asset class
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[Jo-Ann]
Recently the terminal rate for Fed funds pricing has increased, causing the yield curve to invert further by 100 basis points. However, Jo-Ann viewed this as a positive for fixed income, maintaining an optimistic outlook. It was acknowledged that interest rates are likely to be volatile in the coming months, particularly in the front end of the yield curve. The market's response to data points and recalibration of expectations was expected to continue. Another trend observed was an increased appetite for Asia local currency bonds due to strong economic fundamentals, domestic focus, and the reopening of China. Inflation in Asia has been lower than anticipated, leading to stability in local currency rates compared to the US. She also mentioned a high interest in fixed maturity products and buy-and-hold mandates, as investors can secure returns of 5% to 6% for investment-grade bonds with a five-year horizon in USD terms. Overall, 2023 is seen as a year of opportunity for bonds.
[Anthony]
Anthony emphasized the importance of considering relative inflation rates in different markets. It was pointed out that in the US, core inflation is around 5.5% to 6%, even with the assumption of a few more interest rate hikes. This means that investing solely in treasuries would result in negative carry. Similarly, Singapore has even higher core inflation, possibly in the mid-sixes. On the other hand, Hong Kong and China have lower inflation rates, offering the potential for positive carry-in local currency investments. He highlighted the relevance of fixed income in portfolios, especially considering the disparities between inflation and treasury yields. He also mentioned the attractiveness of longer-duration investment-grade bonds paying over 6% in a volatile market environment. The anticipation of rising interest rates creates market volatility, making a fixed-income component valuable for portfolio diversification. Both public and private credit options were suggested as ways to complement portfolio construction.
[Samuel]
It is important to recognize upcoming data, particularly regarding employment and wage inflation, as potential triggers for accelerated rate hikes. It was mentioned that there's a 30% to 40% chance of a 50 basis points hike if the data is strong. However, he also noted that the market has already priced in the expectation of rates exceeding 5%. Looking ahead, Samuel expressed confidence in longer-dated bonds with higher yields as attractive opportunities in the fixed-income market. He suggested that the Fed's more aggressive rate hikes may become problematic if economic growth slows and unemployment rises, potentially leading to the need for rate cuts in the future. Overall, he emphasized on the potential for medium to long-term allocation to fixed income, both in the public and private sectors.
The US dollar Asia credit index has been experiencing negative returns last year primarily due to interest rates. It was noted that the average yield of Asia investment grade is around 5.8%, while the high yield is at approximately 11.4%. With the absolute return fund targeting a 5% return in US dollar terms, Jo-Ann found Asia investment-grade bonds offering sufficient returns without the need to venture into lower credit quality. Investment-grade bonds are better positioned to withstand a downturn due to stronger fundamentals and a more restrictive financial environment. In addition to US dollar Asia investment grade bonds, she expressed optimism for Asia local currency bonds, specifically highlighting Indonesia government bonds as their top pick. Indonesia offers high real yields, fiscal consolidation, and significant coal reserves, which could attract foreign investments. In summary, there is value in both Asia investment grade bonds and Asian local currency bonds.
Fixed income would be a favorable allocation for both 2023 and 2024, particularly for medium to long-term investments. The benefits of fixed income include attractive yields due to current high-interest rates and the potential for positive returns. In a recession scenario or when equities underperform, fixed income serves as a valuable diversification tool. Samuel suggested considering overweighting fixed income in portfolios, with a 40/60 or 60/40 allocation. Looking ahead, it is anticipated that interest rates might stabilize or even decrease, presenting opportunities for capital gains in fixed-income investments. Private credit and alternative assets, especially private credit with its illiquidity premium, were seen as promising options. As interest rates decline, the speaker believed that high-yield bonds would also offer attractive prospects.
Public market debt offers regular pricing and liquidity through active markets, while private debt is often bilateral and lacks a ready secondary market. Public debt also provides leverage opportunities, with higher-rated bonds offering greater leverage potential. Risk-adjusted returns, leverage needs, and target distribution from the fixed-income portfolio are important considerations when contrasting public and private debt. Anthony highlighted various types of private debt, including private equity, trade finance, and distressed debt. It was noted that private debt carries higher risks and requires expertise in managing complex situations. Liquidity and the ability to access additional capital are crucial factors to consider when investing in private debt. Structured products such as fixed coupon notes, provide income but carry an equity component and the possibility of converting exposure to equity at maturity. He also mentioned convertible bonds as another instrument with potential equity exposure. The availability of these investment products depends on having the right advisors and access to private banks or family office advisors. Investors are increasingly diversifying within the fixed-income environment, exploring opportunities from public liquid to more private-style investments.
Venture debt has become increasingly popular in the past few years as a way to gain exposure to venture investments. It is commonly available in the early stages of ventures rather than during the growth stage. Venture debt has become particularly relevant in the current environment where valuations have been negatively impacted, and founders and existing investors aim to avoid dilution. By providing debt financing, venture debt instruments can help maintain valuations during down rounds. This is especially important for companies that struggle to raise funds and do not generate positive cash flows. Being senior in the capital structure, venture debt investors have some protection, although early-stage ventures often lack significant tangible assets. In the event of business decline, venture debt holders may not recover much of their principal if the company lacks valuable intellectual property or assets. However, venture debt offers a relatively safer way to gain exposure to the venture space. These debt structures often include warrants or convertible notes, allowing investors to participate in the upside potential if the venture company performs well. This enables investors to benefit from equity upside while mitigating some of the downside risks associated with pure equity investment. The popularity of venture debt is expected to continue growing as a credit exposure option within the capital structure.
Samuel highlights that people are choosing a 40% equity, 30% alternative, and 30% fixed income allocation. The appeal of a lower equity allocation stems from recent uncertainty and volatility. Defining alternatives is crucial, as private credit still falls under the fixed-income segment, and private equity is tied to US equities. Although alternatives offer the potential for low volatility and higher long-term returns, they remain linked to underlying asset classes. He suggests considering allocations to fund funds, hedge funds, multi-strategy funds, and fund of funds. However, if equities or fixed income experience significant rallies, low-volatility strategies and hedge funds may underperform. Investors should be aware of their asset allocation framework, avoid chasing recent returns or recommendations, and focus on strategic asset allocation. Within alternatives, private equity and private credit are promising, with a potential place for hedge funds. A 30% alternative allocation might be too high for most risk appetites, but a 20% or 10% allocation is suitable. Overall, a 40% equity and 60% fixed income or 30% equity and 70% fixed income allocation is recommended for the current market cycle.
Five key points were discussed using the acronym SLIDE. Firstly, having an allocation to fixed income brings stability due to its low correlation with other asset classes. Secondly, fixed income provides liquidity as it allows investors to subscribe and redeem on a T+3 basis, unlike private debt with longer lock-up periods. It also offers smaller minimum denominations compared to individual bonds. Thirdly, investing in income funds allows for regular dividend payouts, supporting investors in meeting their liquidity objectives (AI for income). Fourthly, fixed income provides diversification by offering immediate access to a wide range of bond issues across maturities, ratings, and geographies, mitigating single-name credit risk. Lastly, allocating a portion of the portfolio to Asia's local currency and corporate bonds enhances risk-adjusted returns, making it an efficient strategy (e for efficiency). In summary, the five key points that Jo-Anna highlighted are stability, liquidity, income, diversification, and efficiency.
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