In this interview, Juan Nozal, portfolio manager at MAPFRE AM, explains why fixed income assets represent an exceptional option, as a way to deal with inflation without having to assume high levels of risk.
Less than two years ago, we lived in a world of much lower interest rates, where fixed income was not a very attractive asset class for investment. In many cases, the returns were negative, so the investment was concentrated in equities, because although it has a higher risk component, it offered better returns. In other words, investing in fixed-income securities was not seen as a way to increase the value of the portfolio, but was treated as a safe-haven asset, to provide protection in the context of concerns about a weakening economy.
However, over the past few years we have had to face numerous challenges, such as the coronavirus pandemic, supply chain disruptions, and production bottlenecks. Then the war between Russia and Ukraine broke out, which in turn led to an energy crisis. All these challenges gave way to an inflationary period, which in turn has caused central banks to tighten their monetary policy in an unprecedented way. All of this has had a strong impact on fixed income.
"At this time, we believe that fixed income assets represent an exceptional option, as a way to deal with inflation without having to assume particularly high levels of risk," explains Juan Nozal, fixed income portfolio manager at MAPFRE Asset Management. "Just a few years ago, anyone who wanted to invest in fixed income had to turn to high-risk corporate bonds, but now you can find attractive yields without as much risk. For example, Spanish 10-year sovereign bonds have been offering yields above 4% (now 3.2%), with their Italian equivalent close to 5%, and with the German Bund at 3%. And in a situation of inverted curves, shorter terms have paid for even more."
What should we be paying attention to this year if we want to understand the evolution of this asset class?Well, obviously you have to keep an eye on the decisions of central banks regarding their policy rates, as well as the messages they convey at their meetings. Many analysts expect 2024 to represent a shift in the cycle. Central banks are sending clear messages that we are nearing the end of a tighter monetary policy cycle, but the actual timing of any change remains unclear, as does the magnitude of any rate cuts they may decide to make. What seems more important to me isthe total amount of those rate cuts, rather than when they might start.
Macroeconomic data is also becoming increasingly important, with greater influence on markets. One way to describe it is to say that financial markets are increasingly reliant on data and sometimes overreact to economic data releases. In short, you have to know how to take advantage of all that volatility.
The upcoming elections are going to be another factor to watch. More than 70 countries will go to the polls this year, and during election years we tend to see more volatility. The U.S. election, which is likely to be the most closely watched as well as the most influential, will take place on November 5 this year. And in addition to their political outcomes, national elections can also increase social tensions or even aggravate geopolitical conflicts with neighboring countries.
Finally, it is likely that during 2024 both public finances and companies will have particularly intense financing needs. And this is where investors may be able to buy at a premium based on the curves existing in the secondary market. Although we are only a month into this new year, we have already seen high levels of emissions from governments. A particularly relevant example has been Spain's historically large issuance (€15 billion) of 10-year syndicated bonds, which were also purchased in record numbers. Another example was seen in Italy, which issued bonds in several tranches (7-year, 15-year and a 30-year tap)."
What are your recommendations regarding the various risk profiles?For conservative investors, we are recommending a particularly high proportion of sovereign debt from more developed (semi-core) countries such as Belgium, and in terms of private fixed income, we are suggesting high-quality (single A) corporate bonds. In terms of maturities, I would focus on the shorter tranches, from one to three years, which, in view of the inverted curves, continue to offer very good yields, sometimes above 3%, and this despite the recent rally in bonds with even shorter maturities. In terms of sectors, I would prioritise the more defensive ones, such as healthcare, consumer retail and telecommunications. These are all sectors with stable incomes and pricing power, providing them with more consistent levels of profit in difficult times.
For investors with a moderate risk profile, I would focus on peripheral countries such as Spain and Portugal, or even Italy, which not only offer higher yields, but are also experiencing better growth compared to other eurozone economies such as France and Germany. We are also focusing on investment grade (IG) bonds, which tend to be better protected against economic slowdown scenarios compared to high yield (HY) bonds. We are taking tactical positions in more cyclical sectors, which often perform better in circumstances of spread compression. We also think that if interest rates go down, this could lead to opportunities in other sectors such as technology and real estate.
Finally, for more risk-tolerant investors, we would include a portion of high-quality HY bonds with an average rating of BB or BB+. However, we would also select those companies very carefully. And in terms of asset types, we would tend to favor financial subordinated debt.
If we look specifically at euro investment grade bonds, what do you think is the best-case scenario for this segment?In terms of the profitability of companies that issue investment-grade bonds, one of the best-case scenarios would be a soft landing of the economy, which is indeed what I think we're going to see. This can even mean slow growth, as long as it's enough to allow corporate profits to rise at the same rate. It also means that inflation will continue to be contained, to allow for looser monetary policy. In turn, those lower interest rates will help boost the flow of capital into private fixed income.
Overall, the selected companies should have strong fundamentals, with good levels of net leverage, in a scenario where many companies can benefit from the lower funding costs that were available prior to the recent interest rate hikes.
En cuanto a los bonos IG en euros, los diferenciales ya no son lo que eran hace apenas unos meses (en algunos casos es incluso discutible que puedan estar infravalorados), pero sus rentabilidades globales siguen siendo atractivas, y su devengo de cupones también es muy interesante. Sin embargo, a pesar de esas atractivas valoraciones, no todo son buenas opciones. Por eso preferimos centrarnos en IG y en empresas caracterizadas por balances saneados, crecimiento principalmente orgánico y flujos de caja suficientes para gestionar situaciones complejas.
While the outlook for fixed income stocks looks generally positive, what are some of the risks we should also be aware of?Well, one risk would be that there would be a significant drop in economic activity and lead to a recession. If that happens, sovereign bonds tend to perform well due to their more defensive nature, while private bonds tend to perform worse, because corporate profits can decline, along with spreads.
Conversely, unexpected economic growth may make central banks doubt whether to ease monetary policy, while creating a risk of a resumption of inflation. Finally, an increase in geopolitical conflicts can also pose a risk. Although it may seem counterintuitive, sovereign bonds can also perform better during periods of geopolitical risk, compared to corporate bonds. However, any of these scenarios would have a very negative impact on global financial markets, increasing volatility, risk premiums, and oil and other commodity prices, which in turn could affect growth.
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