What are the risks and opportunities for fixed income in 2024?
- The renewed supply-driven rise in oil price shows that the risk of inflation rising once more is currently the biggest risk to markets so investors shouldn’t discount higher-for-longer rates.
- There are still potential opportunities in both investment grade and high yield, particularly in short-duration strategies. Investors are also increasingly using active ETFs to “fill the gaps” in standard indices and generate alpha.
- We are seeing Environment, Social and Governance considerations playing an increasingly important role in investors’ portfolios.
What is our current market outlook?
Last year was a very tough 12 months for fixed income markets globally. Equity markets are used to a high level of volatility but to see returns of -10% in fixed income and credit is quite unusual. Since then, market volatility has eased but remains elevated due to uncertainty around central bank decisions.
On the other hand, we are not certain inflation volatility has eased: while we anticipate inflation will decrease in the future, the unpredictability of oil and energy prices could bring unexpected setbacks. This is the main market risk that can influence central bank decisions. On recession, our base case scenario is that momentum is decelerating but we are not entering a tough or deep recession.
How does this currently impact credit markets?
Credit now offers an attractive return of nearly 5% for a duration of below 5 years1 , which has not been the case for over the last decade in the euro market. In the past, some companies issued bonds at 0%, now on average we have coupons at around 4% in investment grade segment and 6-7% in high yield1 .
When looking at the investment grade space, we are looking for companies with good EBITDA, good visibility on cash flow generation, satisfactory leverage and liquidity. These are factors that we see today. On the technical front, there is a lot of demand given these attractive yields and we expect this may continue for the next 12 months.
Are there any opportunities in high yield?
High yield looks quite different to investment grade. High yield has performed extremely well in 2023 because of the macro background which has behaved better than expected at the beginning of the year.
Unfortunately, flows have not been the main driver of performance, rather it was the lack of supply which supported the asset class. Clients are starting to question the impact of higher default rates and the impact of growth on those companies that are smaller and have less room to manoeuvre. Even though default rates have risen, they remain under historical averages, but we anticipate further increases.
In this environment, we continue to see opportunities in short duration high yield strategies as well as strong demand for fixed maturity products.
What role can ETFs play in a fixed income portfolio?
Net inflows in fixed income ETF rose from 23% in 2021 to 32% in 2022. This reflects a trend over the last four years that has seen fixed income ETF AUM almost double in size. The expectation is that this strong growth trend will continue2 .
However, some investors are still not aware they can access such fixed income exposures through an ETF wrapper. For example, institutional investors are used to dealing with direct lines and mutual funds. At AXA IM, our active ETF offering is quite different from the passive ETFs available in the market. Our ETF strategies still offer the benefits of an ETF wrapper but because we are active, instead of merely replicating the index, we can select sectors we think will outperform.
How does AXA IM reflect ESG considerations in portfolios?
AXA IM incorporate ESG principles across our mutual fund and ETF ranges by applying AXA IM Sectorial and AXA IM ESG Standard policies: they represent normative screens such as UNGC violators and sector screens such as controversial weapons and tobacco. For our Euro Credit PAB ETF strategy we have chosen to go beyond by selecting a Paris-Aligned Benchmark (PAB). The main objective of this index is to reduce the carbon intensity by 7% annually and to achieve alignment with the 1.5°C goal of the Paris Agreement. As such, the PAB approach excludes fossil-fuel intensive companies amongst other screens.
Alongside these screens, our credit analysts cover the entire investment universe, looking at financial risk but also risk management discipline. They meet with a lot of the companies we invest in and have regular discussions to understand their business strategy and to assess their ESG risk.
While a rise in inflation remains a substantial risk to markets, with credit currently offering attractive yields and a variety of strategies offering interesting solutions for investors, we believe that going into 2024 there are still opportunities in fixed income.