Bonds have been down but are they out?

13 September 2022
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Bonds have had a rough time in 2022 as rising interest rates and looming talks of a recession on the horizon have hampered performance and vastly reduced debt offerings. It has been a dysfunctional market. Spreads have, however, begun to narrow again recently (in high yield in particular), driven by signals that a US recession could be milder than expected, meaning less stress on corporate cash flows and fewer defaults on riskier bonds. Could this be the time for investors to get involved in bonds again?

While bonds have been imitating their stock market peers as inflation continues to rack capital markets, it could present a unique buying opportunity for those who can put up with the volatility. Bonds can undoubtedly still serve as a hedge against a drawdown should the economy see a recession (widely expected between mid-2023 and the start of 2024) amid rising rates.

Sanlam Investments manage a range of bond funds which offer a diverse exposure to the fixed income market. We look at some areas within this offering:
 

Hybrid Capital (HC)

Peter Doherty, head of fixed income at Sanlam Investments (UK), describes the differentiating aspect of the Hybrid Capital Bond Fund in that the Fund is “buying the cheapest house on the best street.” The idea here is that you have a parent company host with a solid balance sheet with typically investment grade (AA, A, BBB) and buying down in the capital structure, i.e., their most subordinated debt, so the risk of default is in fact much lower than people perceive it to be because of the way these instruments are treated by rating agencies, i.e., they get notched down from senior to tier 3 to tier 2, down to tier 1. This reduction in ratings creates a perception that the risk of default increases dramatically, according to Doherty. Contrary to the perceived risk, he believes that such strong companies would meet their obligations. The alternative to such an approach, Doherty adds, is to buy a higher yielding senior security from a weaker company.

The second part of the HC investment strategy comes from banks and life assurance companies, both having withstood most of the economic turmoil over the past decade and a half. The result for these institutions is that they have cleaned up their balance sheets, regulations have tightened, and they have a lot more capital. As such, it makes them safer than before, thus losing money even less likely.
 

Inflation-linked Bonds

On the government side, the pricing of inflation-linked bonds still shows a small negative real yield over time (i.e., circa real minus 1 or real minus 2) in the G7 markets, which effectively still offers good protection. Should inflation remain within a 6-10 % range, investors should be indexing at that level and getting all the accrual, which is significantly better than nominal bonds, where yields are still hovering between 2-3% in nominal terms. (The real yield is, therefore deeply negative). Although there is a big expectation in markets that inflation will normalise, investors would naturally want to hold inflation-linked bonds if it does not.
 

Corporate Bonds

Without being oblivious to current limits, the big corporates have pricing power and can increase or maintain margins. Hence, exposure to credits with the ability to capture some of the spread makes sense. Regarding Sanlam Investments’ most favoured sector in the Hybrid space, i.e., financials, we have already seen net interest margins having improved for banks’ loan books. Sanlam Investments’ Credit Fund is a long-only corporate bond fund managed by Guillaume Desqueyroux. He looks to keep a defensive strategy whilst structuring the Fund to benefit from market stabilisation. Quoting Desqueroux, “achieving this starts with duration, as shifting duration as short as possible, you effectively limit volatility.” He avers that the second part of the strategy is to look at the company’s capital structure (e.g., banks or insurers) to move away from the most subordinated debt to the more senior debt, offering more protection. The Fund, according to Desqueroux, sits at the entry point of riskier assets (full risk would, of course, mean exposure to equities). Thus, investors have an opportunity to balance risk and reward in the credit spectrum because of the correction we have seen.
 

A cautiously optimistic outlook

Many commentators believe that bonds should continue to deliver the long-term outcomes investors expect from them in a defensive portfolio. For example, in June, bond markets began to warn of a potential recession as short-term yields rose above longer-term bond yields. If these early warnings are correct, as we continue into 2023 and 2024, it could be suitable for fixed-income securities, as they typically perform well in a recessionary environment.

History has illustrated that after a season of negative returns, e.g., in 1994 and 1999, respectively (the only two years of negative bond returns before 2021), bond markets have delivered exceptional returns in the ensuing years. But, as we all know, past performance is not an indicator of future returns, so there are no guarantees this will repeat.

Investors are, however, cautioned by the SI UK fixed income desk to remain careful as markets are currently still seeing a high and persistent inflation backdrop globally. Despite recent increases, bond yields are still relatively low by historical standards. The team suggests that mid to high single-digit yields with modest duration (2-5 years) should provide some solid protection. They add that from there; if one could compound in a circa 8% range in years three through five by taking an investment view instead of a speculative short-term view, one could expect a decent payout.
 
Investors are urged to remain mindful of market volatility; therefore, within the fixed interest space, as with other asset classes, one must be sure of what one owns and buy on the back of adequate research and specific requirements. Given the extraordinary picture we have seen unfold this year of geopolitical conflict and political risk, coupled with high inflation, bond investors can take selective risks to improve their risk/return trade-off.
 



 

Important information

Past performance is not a guide to future performance.  The value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. 

 

Sanlam Credit Fund risks

The Fund will invest in debt securities. The government or company issuer of a bond might not be able to repay either the interest or the original loan amount and therefore default on the debt. This would affect the credit rating of the bond and, in turn, the value of the Fund. Investment in bonds and other debt instruments (including related derivatives) is subject to interest rate risk. If long-term interest rates rise, the value of your shares is likely to fall. The Fund may invest in in derivatives for the purpose of hedging, efficient portfolio management and/or investment purpose. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The Fund may engage in transactions in financial derivative instruments for Share Class hedging purposes only. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

The value of this portfolio is subject to fluctuation and past performance is not necessarily a guide to future performance. The performance is calculated for the portfolio and the actual individual investor performance will differ as a result of initial fees, the actual investment date, the date of reinvestment and dividend withholding tax. All terms exclude costs. Fluctuations or movements in exchange rates may cause the value of underlying investments to go up or down. Do remember that the value of participatory interests or the investment and the income generated from them may go down as well as up and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Therefore, the Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The Manager has the right to close any Portfolios to new investors to manage them more efficiently in accordance with their mandates. Collective Investment Schemes are traded at ruling prices and can engage in borrowing and scrip lending. Collective Investment Schemes (CIS) are generally medium to long term investments. A schedule of fees and charges and maximum commissions is available on request free of charge from sanlam.co.uk. A full summary of investor rights can be obtained from https://www.linkgroup.eu/policy-statements/irish-management-company/. Document is provided in English.

This document is marketing material. Issued and approved by Sanlam Investments which is authorised and regulated by the Financial Conduct Authority (FRN 459237), having its registered office at 24 Monument Street, London, EC3R 8AJ. The UCITS Management Company has the right to terminate the arrangements made for the marketing of funds in accordance with the UCITS Directive.

Tideway UCITS Fund ICAV an Irish collective asset-management vehicle registered under the laws of Ireland having its registered office at 1st Floor, 2 Grand Canal Square, Grand Canal Harbour Dublin 2, Ireland. The ICAV is an umbrella type Irish collective asset-management vehicle with segregated liability between funds incorporated under the Irish Collective Asset-management Vehicles Act 2015 of Ireland and authorised by the Central Bank of Ireland. The Fund Manager is Link Fund Solutions (Ireland) Limited a company incorporated under the laws of Ireland having its registered office at 1st Floor, 2 Grand Canal Square, Grand Canal Harbour, Dublin 2, Ireland which is authorised by the Central Bank of Ireland. Link Fund Solutions (Ireland) Limited has appointed Sanlam Investments UK Ltd as Investment Manager to this fund.

 

Sanlam Hybrid Capital Bond Fund risks

The Fund will invest in debt securities. The government or company issuer of a bond might not be able to repay either the interest or the original loan amount and therefore default on the debt. This would affect the credit rating of the bond and, in turn, the value of the Fund. Investment in bonds and other debt instruments (including related derivatives) is subject to interest rate risk. If long-term interest rates rise, the value of your shares is likely to fall. The yield is gross and could be higher than what you will receive in the future. The Fund may engage in transactions in financial derivative instruments for hedging purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The Fund may invest in Contingent Convertible Securities (CoCos). The value of CoCos is unpredictable and will be influenced by many factors including, without limitation (i) the creditworthiness of the issuer and/or fluctuations in such issuer’s applicable capital ratios; (ii) supply and demand for the CoCos; (iii) general market onditions and available liquidity and (iv) economic, financial and political events that affect the issuer, its particular market or the financial markets in general. The investor may not receive a return of principal if expected on a call date or indeed at any date.

The value of this portfolio is subject to fluctuation and past performance is not necessarily a guide to future performance. The performance is calculated for the portfolio and the actual individual investor performance will differ as a result of initial fees, the actual investment date, the date of reinvestment and dividend withholding tax. All terms exclude costs. Fluctuations or movements in exchange rates may cause the value of underlying investments to go up or down. Do remember that the value of participatory interests or the investment and the income generated from them may go down as well as up and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Therefore, the Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The Manager has the right to close any Portfolios to new investors to manage them more efficiently in accordance with their mandates. Collective Investment Schemes are traded at ruling prices and can engage in borrowing and scrip lending. Collective Investment Schemes (CIS) are generally medium to long term investments. A schedule of fees and charges and maximum commissions is available on request free of charge from sanlam.co.uk. A full summary of investor rights can be obtained from https://www.linkgroup.eu/policy-statements/irish-management-company/. Document is provided in English.

This document is marketing material. Issued and approved by Sanlam Investments which is authorised and regulated by the Financial Conduct Authority (FRN 459237), having its registered office at 24 Monument Street, London, EC3R 8AJ. The UCITS Management Company has the right to terminate the arrangements made for the marketing of funds in accordance with the UCITS Directive.

Tideway UCITS Fund ICAV an Irish collective asset-management vehicle registered under the laws of Ireland having its registered office at 1st Floor, 2 Grand Canal Square, Grand Canal Harbour Dublin 2, Ireland. The ICAV is an umbrella type Irish collective asset-management vehicle with segregated liability between funds incorporated under the Irish Collective Asset-management Vehicles Act 2015 of Ireland and authorised by the Central Bank of Ireland. The Fund Manager is Link Fund Solutions (Ireland) Limited a company incorporated under the laws of Ireland having its registered office at 1st Floor, 2 Grand Canal Square, Grand Canal Harbour, Dublin 2, Ireland which is authorised by the Central Bank of Ireland. Link Fund Solutions (Ireland) Limited has appointed Sanlam Investments UK Ltd as Investment Manager to this fund.

 

Sanlam International Inflation-Linked Bond Fund risks

The Fund will invest in debt and debt-related securities. The government or company issuer of a bond might not be able to repay either the interest or the original loan amount and therefore default on the debt. This would affect the credit rating of the bond and, in turn, the value of the Fund. If long-term interest rates rise, the value of your shares is likely to fall. The Fund may invest in companies based in emerging markets, which may involve additional risks due to greater political, economic, regulatory risks, among other factors. Financial derivative instruments may be used for the purpose of hedging and efficient portfolio management. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

The value of this portfolio is subject to fluctuation and past performance is not necessarily a guide to future performance. The performance is calculated for the portfolio and the actual individual investor performance will differ as a result of initial fees, the actual investment date, the date of reinvestment and dividend withholding tax. All terms exclude costs. Fluctuations or movements in exchange rates may cause the value of underlying investments to go up or down. Do remember that the value of participatory interests or the investment and the income generated from them may go down as well as up and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Therefore, the Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The Manager has the right to close any Portfolios to new investors to manage them more efficiently in accordance with their mandates. Collective Investment Schemes are traded at ruling prices and can engage in borrowing and scrip lending. Collective Investment Schemes (CIS) are generally medium to long term investments. A schedule of fees and charges and maximum commissions is available on request free of charge from the Manager, the Investment Manager or at www.sanlam.co.uk. A full summary of investor rights can also be found online at www.sanlam.com/ireland/Documents/SAMI%20Shareholder%20Engagement%20Policy.pdf. Documents are provided in English.

This document is marketing material. Issued and approved by Sanlam Investments which is authorised and regulated by the Financial Conduct Authority (FRN 459237), having its registered office at 24 Monument Street, London, EC3R 8AJ. The UCITS Management Company has the right to terminate the arrangements made for the marketing of funds in accordance with the UCITS Directive.

 

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Marketing material. Issued by Salam Investments UK Limited. Authorised and regulated by the Financial Conduct Authority. Registered office: 24 Monument Street, London, EC3R 8AJ. The value of investments can go down as well as up and investors may not get back the full amount invested.

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