Where will investors find the most value in fixed income?

Bond markets enjoyed a spectacularly strong rally at the end of 2023 that took many industry observers by surprise. But what’s the outlook for the rest of this year? Where will fixed income investors find the most value? What are the key concerns? Is the economic backdrop supportive?

Here we take a look at how confident three leading managers of bond portfolios are feeling about interest rates for 2024 and where they are currently positioned.

Nomura Global Dynamic Bond

Richard ‘Dickie’ Hodges, manager of the Nomura Global Dynamic Bond fund, believes investors must pay attention to what Central Banks are saying – particularly the US Federal Reserve*.

“The Fed have reiterated that they expect to cut rates by 75bps in 2024,” he said. “They have not yet been specific as to the timing of those rate cuts but have repeatedly stated that they expect to keep rates on hold for a period of time before they begin.”

The Fed wants further confirmation that inflation is trending down towards its 2% target*, Dickie points out. This fits with his view that rate cuts will begin around the middle of the year. “Recently released data indicating a relatively strong labour market and the upside inflationary risk associated with ongoing attacks in the Red Sea only serve to increase our belief that early rate cut expectations (in March, for instance) are likely to be disappointed,” he added.

Elsewhere, Dickie expects the European Central Bank (ECB) to keep rates on hold until the Fed begins cutting, despite the clear weakness in the Eurozone. “The Bank of England has an even more thorny position to navigate,” he said. “Inflation in the UK seems particularly persistent, so it appears unlikely that they will begin to cut rates imminently.”

Dickie’s portfolio is an unconstrained strategic bond fund, with a focus on total returns. It invests in the entire range of bond sectors, including government, corporate and inflation linked bonds.

TwentyFour Corporate Bond

Last year may have ended on a positive note, but there are still plenty of unknowns to face, according to Gordon Shannon of TwentyFour Asset Management**.

“Geopolitical risks are multiplying, economists are still unsure as to whether the US economy is going to achieve a hard of soft landing, and the UK and Europe flirt with recession,” he said. While he believes the current level of yield provides a useful buffer against volatility, he still believes it’s important to build robust portfolios that can change to the evolving backdrop**. “A key driver of where global relative value will be found this year is the degree to which central banks act in concert or diverge in their approach,” he said.

Gordon also finds it interesting that the market is pricing in the same number of interest rate cuts from the ECB over the coming year as the Fed. That’s despite the “rapidly emerging disinflation” and an economy close to recession in Europe, while US growth is buoyant. Investors, he warned, can’t just be data dependent. “We have to be open to a changing narrative of how policymakers will react to that data,” he added. “With the Fed, ECB and Bank of England at terminal rates and now actively considering interest rate cuts, we have more options to us in our portfolios now.”

The TwentyFour Corporate Bond fund, managed by Chris Bowie, looks to achieve the highest possible income, with the least amount of volatility. Although it mostly holds investment-grade bonds, due to its focus on minimising risk, it will selectively hold high yield or floating rate bonds.

Liontrust Sustainable Future Monthly Income Bond

Corporate bonds performed strongly in the final quarter of 2023 and this could continue, according to the three co-managers of Liontrust Sustainable Future Monthly Income Bond fund.

Kenny Watson, Aitken Ross and Jack Willis believe these assets can do well despite the challenging economic growth outlook. “Corporate fundamentals remain  robust, with low levels of leverage, high interest coverage and ample liquidity,” they wrote.

While acknowledging corporate fundamentals will “inevitably weaken through a period of economic deterioration”, they remain confident investment grade companies can navigate this period***. “Defaults are not expected to tick up beyond the long-term average, so current levels of return more than adequately compensate for inherent risks and provide an attractive entry point,” they added.

More broadly, the trio remains underweight consumer sectors as this is where the delayed impact of interest rate hikes is yet to have its full impact***. “The fund remains overweight financials, based on attractive valuations and this is expressed through overweight positioning to both the banks and insurance sectors,” they said. They are also overweight telecoms, partly due to their growth characteristics***. “We are constructive on the prospects for corporate bonds, based on attractive valuations and strong fundamentals.

The aim of the Liontrust Sustainable Future Monthly Income Bond fund is to produce a monthly income, with some capital growth. It mainly invests in corporate bonds and some government bonds but has the flexibility to move between shorter or longer dated to take advantage of interest rate changes.

*Source: Nomura, Dickie’s View, February 2024

**Source: TwentyFour, Investment Grade Quarterly Update, January 2024

***Source: Liontrust, SF Monthly Income Bond, Q4 2023 review