Is the fixed-income market ripe for yield-hunting amid volatility? Here’s where to look, according to analysts

[SINGAPORE] Fixed-income assets have turned in a mixed performance amid market volatility arising from the Middle East conflict.

The 10-year US Treasury yield reached 4.285 per cent on Friday (Mar 13), while the two-year Treasury note yield slipped more than two basis points to 3.734 per cent.

Alfonso Borges, fixed-income analyst at Julius Baer, said that the Iran war has affected US Treasury yields. Since the US and Israel commenced strikes on Iran on Feb 28, yields have widened relative to the swap curve.

“A possible reason is that fixed-income investors are pricing a deterioration in public finances due to the cost of the war, plus measures to alleviate the pass-through of energy costs to consumers,” he said in a Thursday note.

Joven Lee, multi-asset strategist at Schroders, pointed to other “shocks” that are “growth, inflation or policy-driven” as also having an impact on fixed-income assets. These include a stronger US dollar after the war broke out, and the US’ fourth-quarter gross domestic product growth tapering to 0.7 per cent.

With fixed income facing various pressures in uncertain times, can it still serve as a safe haven for investors? And if so, where should they look?

Opportunity in volatility

Market volatility is likely to create opportunities for active managers to deliver positive returns in fixed income, said Julien Houdain, head of global unconstrained fixed income at Schroders.

“Income is still there and attractive,” he said. “Real yields are massive… (and) protect you against volatility in the market; it’s a strong investment.”

He said that even with a very safe portfolio, where there is no financial engineering and limited exposure to higher-risk segments, investors could still generate a yield of around 5 to 6 per cent.

That said, a continued surge in oil prices would significantly increase the trajectory of short-term inflation, and affect various fixed-income assets.

“This is a key risk to bond investors,” said Steve Brice, global chief investment officer at Standard Chartered’s Wealth Solutions unit. “Therefore, it is important for investors to continue to include inflation hedges in their portfolio.”

He said that this could include floating rate debt, inflation-protected securities, equities, real estate and gold.

Short-duration, investment-grade bonds

Experts such as Maurice Meijers, high-yield client portfolio manager at Robeco, said that short-duration bonds are preferred to their long-duration counterparts as they are less reactive to volatility.

“With short-duration bonds, one has cash coming off every month or every quarter, which investors can then put to work once (geopolitical tensions) start to settle down,” he explained.

A similar sentiment was echoed by Houdain, who warned against excessive long-duration exposure, while noting that investors should focus on the “zero-to-five-year part” of the curve.

“Beyond 10 to 30 years, central banks cannot fully control what happens if deficits remain large,” he said in a Friday note. “They can intervene, as we’ve seen in Japan, the US during the financial crisis or more recently in the UK at the long end – but that doesn’t remove the structural pressure.”

Commenting on the US Treasury market, Meijers said more time may be required to tell if Treasuries have benefited from a true flight to safety. “(This is something) long-term bonds tend to really benefit from.”

Houdain said a further rise in yields in US Treasuries at this point would signal “a potential opportunity to get long”, though he remains cautious on the market for now.

Experts generally prefer investment-grade to junk bonds during volatile periods. The former tends to offer a steadier stream of income amid market swings.

For example, the Schroder ISF Global Credit Income A Distribution strategy, an investment-grade fund managed by Houdain, has delivered “double-digit” cumulative growth since 2022, he shared at a roundtable session on Mar 6.

Australian credit

One category within fixed income that has stood out during this time is Australian credit, which experts have noted as a “high-quality market”.

“The duration is lower, and the credit quality is higher,” said Dorian Carrell, head of multi-asset income at Schroders, at the Mar 6 roundtable session.

Various news reports indicate that Australian-listed private credit funds trade on average at around a 2 per cent discount to their underlying assets.

Certain trusts, particularly those with larger real estate equity positions or more complex structures, are marked down far more, with discounts closer to 17 to 20 per cent.

The Aussie Corporate, an online platform covering Australian corporate culture, noted that this gap is “creating opportunities for specialists willing to take a longer view”.

The country is one of the largest net exporters of energy, Meijers explained, making it “well positioned” to capture what markets are reacting to presently.

“Banks and insurance companies dominate nearly half the credit market in Australia,” said the analyst. “It could be an option for those who wish to dip back into markets once things begin to settle, and offer some opportunities.”