In a world of rising yields and inflation, what can active fixed income investors expect next year? Fixed income portfolio managers from across Insight Investment, part of BNY Mellon Investment Management, survey the changing market landscape as we head into 2024.
By Adam Whiteley, portfolio manager of the BNY Mellon Global Credit Fund
For the start of 2024, we expect a continuation of credit market conditions experienced in 2023, namely a general
lack of compensation for uncertainty in credit spreads. So, while we believe that recession will be avoided in the US, UK and Eurozone, unfortunately this does not mean the outlook is especially positive.
In 2024, a big focus will be on determining where markets are in the credit cycle, whether economies are expanding or contracting at the same pace and how this will affect different sectors within the fixed income arena. This is crucial for determining when and where the key investment risks lie and, as such, getting this right and the relative value opportunities it brings. This could be the key opportunity in 2024.
Short-Dated High Yield Bonds
By Uli Gehrard, Cathy Braganza and Lorraine Specketer, portfolio managers of the BNY Mellon Global Short-Dated High Yield Bond Fund
Overall, the outlook for the high yield and shorter-ended end of the market is positive. But investors will need to adapt their approach to a market which has fundamentally changed from the immediate aftermath of the global financial crisis. From 2012 to 2020, investors didn’t really need to do any major credit analysis. At the time, key factors in the market were driven by interest rate movements and actions of the central banks.
Now it’s different. We are in a place where bottom-up credit analysis and cashflow modelling are vitally important again. Looking ahead into 2024 and beyond, the quality of this analysis will separate the fund managers who will succeed in this market and generate strong returns from those who will not.
In terms of threats, we expect to see some defaults, perhaps in the 3-4% range, though we also believe the overall default level will not be as high as we have seen in the recent past. There are potential problem sectors. Some real estate companies whose debt has fallen from investment grade to high yield do look potentially vulnerable.
Yet as a whole, the stability and strength of the high yield debt market has generally improved in recent years. High yield issuing companies have tended to become much bigger and more stable, while the credit quality of high yield indices has also improved over time.
European Impact Bonds
By Fabien Collado, portfolio manager of the BNY Mellon Responsible Horizons Euro Impact Bond Fund
Post-2022 and the Russian invasion of Ukraine, increased awareness of the need for energy security and safety in Europe massively ramped up the requirement for renewable energy in the region. Renewable energy utilities were actually some of the first companies to issue impact debt assets in Europe and this is a fairly well-established market. The ongoing move away from using fossil fuels means we will need to continue strengthening renewable capabilities in Europe. This is not a new area for investors but we believe renewable energy and its rollout will continue to be one of the most important drivers of impact bond growth in the European corporate impact bond space in the year(s) ahead.
In terms of threats, the European property investment market has seen some mixed fortunes in 2022/23, with large parts of the sector performing extremely poorly on the back of rising interest rates. This sector is highly relevant to impact bond investors as it has seen a tremendous amount of green bond-related issuance in recent years. Overall, while we believe the sector holds significant potential for careful stock selectors, we also believe it merits some degree of investor caution.
Impact bonds can deliver beneficial results across a range of sectors. But it is crucial for investors to continue running fundamental impact analysis. Impact bonds bring a tremendous amount of transparency to investors, who need to ensure they are selecting projects with the highest level of positive impact.
Emerging Market Impact Debt
By Simon Cooke, portfolio manager of the BNY Mellon Responsible Horizons Emerging Market Debt Impact Fund
The current growth environment favours emerging markets (EMs) over developed markets (DMs). However, at a macroeconomic level, much will depend on what happens in DMs in the year ahead and thus we adopt a cautious outlook in the short term.
While most EMs are seeing relatively strong economic growth, the external influence of economic conditions in DMs, currently grappling with uncertain growth, inflation, and rate environments, could inject some potential uncertainty. The good news for EM corporates is that coming into this higher rate, slower growth environment, their leverage is at its lowest, and the interest cover at its strongest, for a decade.
Elsewhere, default risk is always a potential threat. As in other credit markets, we would expect default rates to increase in the year ahead, but without seeing a major spike in defaults outside of well-known trouble zones such as China property, Russia and Ukraine. Investors in both EMs and DMs now tend to be much less forgiving of companies in difficulty than they were in the past, making stock selection increasingly important.
Over the next three to five years, we see structural opportunities in specific areas within EMs, including telecoms infrastructure development and renewables, as their infrastructure is built out across EMs. Both sub-sectors tend to attract businesses with the potential for structural growth. With telecoms in particular there is huge growth potential in markets such as East, West and Southern Africa, where millions of people currently live without access to 4G telecoms coverage.
Elsewhere we are excited by innovation we are seeing in impact bond markets across EM. The world’s first tradeable blue bond, biodiversity bond and gender equality bond all came from emerging markets and we expect to see more innovation over the next 12-18 months.