Defensive is the play for 2024 as the UK looks set to enter recession, with the impact of higher rates starting to hit the real economy. But with the yield curve inverted, investors have an exciting opportunity to increase yield by taking less interest rate and credit risk. As we enter 2024, Kris Atkinson, fixed income portfolio manager at Fidelity International, outlines why a defensive income offering looks attractive via short dated, high-quality corporate bonds.
“As we look towards 2024, we remain positive on Sterling investment grade credit with there being attractive opportunities in both yield and credit spread terms. As credit investors, one of the biggest opportunities that we have is the additional yield that we earn over Gilts, the ‘credit spread’.
“It is very hard to predict the road ahead, although it seems inflation is coming down and each additional data print reinforces that. However, with growth looking anaemic, we are teetering along the edge of a recession, which makes our conviction around defensive fixed income much higher than risky assets.
UK PMI data has slightly improved but remains weak
Source: Fidelity International, Bloomberg, 30 November 2023.
“There has been a lot of talk about the lack of transmission between higher rates to the real economy, but we’re now starting to feel the effects of the initial rate hikes. We are moving towards late-cycle dynamics, with rates remaining high and credit conditions tightening. We are seeing this through an increase in the level of volatility and dispersion within individual equities and credit spreads. This transmission mechanism will likely continue through 2024 and probably beyond that. With an inverted yield curve, there is a unique opportunity for investors at the short end of the curve to add yield and take less risk.
“In the Fidelity Short Dated Corporate Bond Fund, as the transmission of higher rates hits the real economy, we are positioning ourselves more defensively. We have increased our weighting to utilities, which are inflation protected and defensive in downturns, and lifted our Gilt exposure to support liquidity in the portfolio. Across sectors we have a preference towards secured bonds, which translates into a meaningful overweight.
“The short end looks particularly attractive. With the inversion of the yield curve, investors can now achieve more yield in short dated corporate bonds versus longer dated bonds. Accordingly, we have been implementing shortening trades in the portfolio, allowing us to pick-up more yield for less risk. This positions the portfolio more towards a recessionary outcome if central banks have to cut rates, given the short end is particularly sensitive to interest rate policy.
“Higher levels of volatility and uncertainty offers a unique opportunity for our active management approach as negative headlines tend to get an oversized reaction from markets.”
