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Bonds offer portfolio diversification and a guaranteed income stream that should be higher than cash.
The cold, stark reality is that rising rates in general are as harmful to bonds as gravity is to falling apples. It is pure physics and indeed undeniable. Hence, one’s gut reaction to the spectre of rising rates might be to abandon the fixed income credit asset class altogether. However, we believe that this decision would be both overly simplistic and ill-founded. At its core, bonds offer portfolio diversification and a guaranteed income stream that should have returns higher than cash. However, investors will need to recalibrate their view of the asset class, recognising that prospective returns over the next few years will not likely match the bull-market realisations that existed for much of the past several decades. They will also have to view the asset class in the context of a long-term strategic allocation.
Going forward, we would advocate a multi-pronged strategy toward credit investing focusing on four key considerations:
The global USD Credit market is not homogenous, and different asset classes are better placed to perform in a rising interest rate regime. In this climate we prefer Credit exposure to Rates exposure. We are maintaining our Market Weight call on Emerging Markets High Yield. The asset class offers the most attractive valuation, balance sheets are generally improving, and credit spreads should provide a significant cushion against rising rates. We are also keeping our Market Weight call on U.S High Yield, which is well-placed to offer positive returns (albeit lower than Emerging Market High Yield) given the sector’s well-below historical average default rates. We are maintaining our Underweight recommendations on U.S and Emerging Market Investment Grade. Both credit classes offer inadequate spread cushion to off-set rising rates, with the former’s high duration and historically low spreads making it particularly susceptible to the detrimental impact of rising rates.
This article was first published by Bank of Singapore on Feb 14, 2022. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.
OCBC NISP Private Banking provides a suite of products for wealth creation, preservation and transmission including holistic wealth management services, independent research, customized solutions for all investor preferences, and genuine open architecture, with expertise in Indonesia and Asia Pacific markets. OCBC NISP Private Banking is a part of OCBC Group.
