As the ‘buy-everything’ rally kicked off in late 2023 fades, fixed income investors will need to be a little more discerning in their shopping habits, according to Leon Grenyer, Morgan Stanley Investment Management (MSIM) head of European multi-sector.
In NZ last week on tour with Salt Funds Management, Grenyer said the bond market enthusiasm sparked by hopes of a US Federal Reserve ‘pivot’ to early rate cuts in 2024 has since dissolved into a more nuanced view of the risks and opportunities in the asset class.
The latest mood change follows a torrid 12 months for fixed income managers that evolved through three distinct phases starting with a mini US banking crisis last February. After US regulators contained a bank run that claimed three major institutions, bond market worries centred once more on persistent inflation and ‘higher for longer’ rates before a dovish Fed u-turn in November saw both risk-free and risky fixed income assets soar.
By February this year, conflicting economic data prompted investors to rein-in early Fed cut predictions, pushing long-term rates slightly higher even as the yield curve remains inverted – a traditional harbinger of recession.
“It has been an unusual period in fixed income,” Grenyer said.
The volatile 12-month stretch also coincides almost exactly with lifespan of the Salt Sustainable Global Fixed Income Opportunities Fund, which launched last February with MSIM as underlying manager.
“Pleasingly, the Salt fund has outperformed early and participated in the more recent [bond market] upgrade,” he said.
Since inception until the end of January this year, the Salt fund – which feeds into a subset of an underlying MSIM strategy – was up more than 5.5 per cent (gross) compared to over 3.5 per cent for the benchmark Bloomberg Global Aggregate.
But the “total return” style takes the MSIM-managed Salt fund far from the index, Grenyer said.
“We don’t pay attention to the benchmark,” he said. “We’re looking for the best ideas based on our macro views, market intelligence and research team’s view to generate alpha in all parts of the fixed income market and through cycles.”
In practice, the approach leads to a select portfolio, actively traded across the spectrum from risk-free sovereign bonds to high-yield credit and currencies. The longer-running MSIM sustainable fixed income fund holds about 400 securities at the moment compared to 250 or so in the Salt vehicle.
Currently, the strategy is underweight duration with overweight positions in European investment-grade credit and US securitised assets (especially residential), for example.
About half of the portfolio is exposed to US assets.
Greg McMaster, Salt head of client partnerships, said the MSIM-managed wholesale fund has accrued about $85 million from local investors including iwi, charities and superannuation schemes with a strong pipeline ahead.
McMaster said while the more flexible, total-return style is part of the attraction for some, the sustainability angle is also important.
“The fund has a much lower carbon intensity than the benchmark as well as an objective to maintain a meaningful allocation to green- and sustainable-labelled bonds,” he said.
MSIM applies a sophisticated environmental, social and governance (ESG) overlay to the bond portfolio – via its specialist research subsidiary, Calvert – that screens out the usual ‘sin’ sectors while allocating more to green bonds and the like.
After a horror 2022 when global bond markets fell sharply in line with equities, fixed income has emerged on the other side in a healthier, if more differentiated, state.
Grenyer said bonds should reassert their traditional role as portfolio diversifier despite moving in lock-step with share markets during the 2022 slump and the more recent ‘everything rally’.
However, nothing is guaranteed.
For example, stickier-than-expected inflation and tighter-for-longer monetary policy could derail the consensus narrative for fixed income investors – and markets in general.
Grenyer said investors will need to keep a sharp eye on risk premia opportunities throughout the fixed income universe as the cycle unfolds.
“We have an active and dynamic asset allocation that allows us to respond quickly to changes in the market,” he said.
The Salt Sustainable Global Fixed Income Opportunities Fund is a wholesale-only fund, although retail investors have some exposure to the strategy via the manager’s diversified products.