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The return of bonds

Where are the best opportunities as fixed income moves towards a new paradigm?

present

READ THE ARTICLE

With rate cuts looking increasingly likely, could fixed income investors benefit
from holding higher rated debt?

Pockets of opportunity in investment grade

READ THE ARTICLE

Restricted supplies of new bonds from companies reluctant to borrow at today’s
higher rates coupled with high demand from investors are creating a powerful
technical backdrop for the corporate bond market

The ‘acute pain trade’ in UK corporate bonds

READ THE ARTICLE

Why now is the time to seize opportunities in the bond market to add income and
pursue enhanced total returns

Income opportunities: The case for bonds now

READ THE ARTICLE

Elevated yields and the end of central bank rate-hiking cycles may generate
alpha opportunities when viewing bonds through a relative value lens

Fixed income returns to prominence

READ THE ARTICLE

With holders of cash potentially about to be caught out by cuts in interest
rates, why does short-dated fixed income offer a natural home for this capital?

Short-dated corporate bonds: A natural next step for cash investors

READ THE ARTICLE

Why it’s not too late for fixed income investors to take advantage of elevated
yields

Fixed income opportunities: Evaluating spreads vs. yields

READ THE ARTICLE

Smaller issuers in the high-yield market have traditionally returned more than
their larger peers and lost less during times of crisis. So why don’t more funds
hold them?

Have you spotted the ‘moonwalking bear’ of high-yield debt?

READ THE ARTICLE

Inflation that runs above target without being disruptive and below-trend growth
that leaves room for corporate spending could offer a great opportunity for
fixed income

Why bonds are in a buy zone

Latest insights

READ THE ARTICLE

With rate cuts looking increasingly likely, could fixed income investors benefit
from holding higher rated debt?

Pockets of opportunity in investment grade

READ THE ARTICLE

Restricted supplies of new bonds from companies reluctant to borrow at today’s
higher rates coupled with high demand from investors are creating a powerful
technical backdrop for the corporate bond market

The ‘acute pain trade’ in UK corporate bonds

READ THE ARTICLE

Elevated yields and the end of central bank rate-hiking cycles may generate
alpha opportunities when viewing bonds through a relative value lens

Fixed income returns to prominence

READ THE ARTICLE

Why now is the time to seize opportunities in the bond market to add income and
pursue enhanced total returns

Income opportunities: The case for bonds now

READ THE ARTICLE

Why it’s not too late for fixed income investors to take advantage of elevated
yields

Fixed income opportunities: Evaluating spreads vs. yields

READ THE ARTICLE

Inflation that runs above target without being disruptive and below-trend growth
that leaves room for corporate spending could offer a great opportunity for
fixed income

Why bonds are in a buy zone

READ THE ARTICLE

Smaller issuers in the high-yield market have traditionally returned more than
their larger peers and lost less during times of crisis. So why don’t more funds
hold them?

Have you spotted the ‘moonwalking bear’ of high-yield debt?

READ THE ARTICLE

With holders of cash potentially about to be caught out by cuts in interest
rates, why does short-dated fixed income offer a natural home for this capital?

Short-dated corporate bonds: A natural next step for cash investors

Latest insights

The return of bonds

Where are the best opportunities as fixed income moves towards a new paradigm?

present

Important information For Professional Clients only and not to be distributed to
or relied upon by retail clients. Past performance is not a guide to future
performance. Opinions and examples represent our understanding of markets: they
are not investment recommendations advice. All data is sourced to Aegon Asset
Management UK plc unless otherwise stated. The document is accurate at the time
of writing but is subject to change without notice. Data attributed to a third
party is proprietary to that third party and is used by Aegon Asset Management
under licence.   Aegon Asset Management UK plc is authorised and regulated by
the Financial Conduct Authority. Adtrax 6105984.1; Expiry 30 April 2025

Income opportunities: the case for bonds now

OTHER ARTICLES FROM AEGON

Learn more about Aegon Asset Management

Even if spreads or yields widen from here, the breakeven rate for bonds is now
considerably more attractive. The breakeven rate measures how high yields (or
spreads) would need to rise before the total return of a bond becomes negative,
typically over a one year time horizon. The total return of a bond has two
components: price return and income return from coupon payments. Prior to 2022,
there was little income or yield available from newly issued bonds as markets
had a prolonged period of low interest rates. However, as rates have shifted
higher, yields across fixed income have risen and newly issued debt now offers
higher coupon rates. Therefore, bond prices can now fall by a much greater
degree before the total return becomes negative. For example, the yield on the
US High Yield Bond Index can rise from the current level of 7.9% to over 10% -
through wider spreads and/or higher core yields - before total returns break
even. For US investment grade, yields can widen by 100 bps before investors lose
money. This cushion is the biggest it has been for over a decade.

While there are attractive opportunities for fixed income investors to take
advantage of current yields, we are cognisant that risks remain. While not our
base case, reacceleration in inflation or a deeper-than-expected recession,
could impact future returns. Therefore, an active management approach is
necessary to navigate fixed income markets.

Enhanced breakeven rates

Corporate bond spreads have narrowed to lows not seen since 2022. As the cycle
extends and economy slows, it is no wonder investors are starting to worry about
potential spread widening given the upside for capital returns is now more
limited. However, the attractiveness of asset classes can be evaluated using
various metrics including yields, spreads, expected returns, etc. Many fixed
income assets offer higher yields than has been normal in the last decade. Fixed
income also offers enhanced income as coupon rates have reset higher. While
spread levels look less compelling, all-in yields and higher coupons remain
attractive.

Spreads have narrowed, but yields remain attractive

Rising rates have led to attractive yields across the fixed income market.
However, corporate credit spreads are tight. This leaves many investors
grappling with the valuations conundrum, as they debate yields versus spreads to
determine their fixed income allocations. Will slowing economic conditions
result in spread widening? Do higher yields provide a sufficient cushion against
downside risk? And is now the time to add fixed income exposure? In our view,
it’s not too late for fixed income investors to take advantage of elevated
yields.

Although spreads are tight, investors mustn’t lose sight of the bigger picture.
Over the long term, the starting yield has been a steady indicator of future
long-term total returns. As shown below, the starting yield-to-worst for the
high yield index has been close to the subsequent annualised five-year return.
This relationship has generally held true in strong and weak economic
environments, as well as periods with tight and wide spreads, With high yield
corporate bonds offering a starting yield to worst around 7.7%, we continue to
like the asset class on a yield basis.

Past performance doesn’t predict future returns, but can yields?

Enhanced breakeven profile for corporate bonds

Source: Aegon Asset Management, Bloomberg as at 31 December 2023. Based on the
ICE BofA Global High Yield Index. Past performance is not a guide to future
performance.

GO BACK

VIEW MORE

0

5

10

15

20

25

Jan 22

Jan 18

Jan 14

Jan 10

Jan 06

US High Yield index - YTM (%)

Breakeven calculator

Yield rises > 300bps to 11% for negative total return

Yield unchanged = 7.9% return

Yield falls 100bps to 6.9% = 11% return

2 / 2

Breakeven calculator

Yield rises > 100 for negative total return

Yield flat = 5.5% return

Yield falls 100bs for >13% return

0

2

4

6

8

10

Jan 22

Jan 18

Jan 14

Jan 10

Jan 06

US Investment Grade index - YTM (%)

1 / 2

Yield to Worst

5 Year Forward Annualised Return (%)

24

22

20

18

16

14

%

12

10

8

6

4

2

0

GO BACK

VIEW MORE

Starting yields have been a reasonable estimate 5 year returns

ICE BofA Global High Yield Index monthly YTW and forward 5 year index returns

8.8

9.1

6.1

6.0

8.8

8.4

Dec 2009 Post-GFC rally

Dec 2012 Prior to Taper Tantrum

Jan 2016 Energy crisis

2 / 2

20.8

22.0

7.4

7.3

12.9

13.8

Oct 2002 Tech bubble

May 2007 Pre-GFC tight spreads

Nov 2008 GFC wide spreads

1 / 2

Source: Aegon Asset Management, Bloomberg as at 31 December 2023. Based on the
ICE BofA Global High Yield Index. Past performance is not a guide to future
performance.

Mark Benbow, portfolio manager

Thomas Hanson, head of Europe high yield

Colin Finlayson, portfolio manager

Alex Pelteshki, portfolio manager

CONTRIBUTORS

Fixed income opportunities: Evaluating spreads vs. yields

Why it’s not too late for fixed income investors to take advantage of elevated
yields

RETURN TO HOMEPAGE

The return of bonds

Important information For Professional Clients only and not to be distributed to
or relied upon by retail clients. Past performance is not a guide to future
performance. Opinions and examples represent our understanding of markets: they
are not investment recommendations advice. All data is sourced to Aegon Asset
Management UK plc unless otherwise stated. The document is accurate at the time
of writing but is subject to change without notice. Data attributed to a third
party is proprietary to that third party and is used by Aegon Asset Management
under licence.   Aegon Asset Management UK plc is authorised and regulated by
the Financial Conduct Authority. Adtrax 6105984.1; Expiry 30 April 2025

Income opportunities: the case for bonds now

OTHER ARTICLES FROM AEGON

Fixed Income opportunities: evaluating spreads vs. yields

1 / 3

>

<

Income opportunities: the case for bonds now

OTHER ARTICLES FROM AEGON

Learn more about Aegon Asset Management

Even if spreads or yields widen from here, the breakeven rate for bonds is now
considerably more attractive. The breakeven rate measures how high yields (or
spreads) would need to rise before the total return of a bond becomes negative,
typically over a one year time horizon. The total return of a bond has two
components: price return and income return from coupon payments. Prior to 2022,
there was little income or yield available from newly issued bonds as markets
had a prolonged period of low interest rates. However, as rates have shifted
higher, yields across fixed income have risen and newly issued debt now offers
higher coupon rates. Therefore, bond prices can now fall by a much greater
degree before the total return becomes negative. For example, the yield on the
US High Yield Bond Index can rise from the current level of 7.9% to over 10% -
through wider spreads and/or higher core yields - before total returns break
even. For US investment grade, yields can widen by 100 bps before investors lose
money. This cushion is the biggest it has been for over a decade.

While there are attractive opportunities for fixed income investors to take
advantage of current yields, we are cognisant that risks remain. While not our
base case, reacceleration in inflation or a deeper-than-expected recession,
could impact future returns. Therefore, an active management approach is
necessary to navigate fixed income markets.

Enhanced breakeven rates

Although spreads are tight, investors mustn’t lose sight of the bigger picture.
Over the long term, the starting yield has been a steady indicator of future
long-term total returns. As shown below, the starting yield-to-worst for the
high yield index has been close to the subsequent annualised five-year return.
This relationship has generally held true in strong and weak economic
environments, as well as periods with tight and wide spreads, With high yield
corporate bonds offering a starting yield to worst around 7.7%, we continue to
like the asset class on a yield basis.

Past performance doesn’t predict future returns, but can yields?

Corporate bond spreads have narrowed to lows not seen since 2022. As the cycle
extends and economy slows, it is no wonder investors are starting to worry about
potential spread widening given the upside for capital returns is now more
limited. However, the attractiveness of asset classes can be evaluated using
various metrics including yields, spreads, expected returns, etc. Many fixed
income assets offer higher yields than has been normal in the last decade. Fixed
income also offers enhanced income as coupon rates have reset higher. While
spread levels look less compelling, all-in yields and higher coupons remain
attractive.

Spreads have narrowed, but yields remain attractive

Rising rates have led to attractive yields across the fixed income market.
However, corporate credit spreads are tight. This leaves many investors
grappling with the valuations conundrum, as they debate yields versus spreads to
determine their fixed income allocations. Will slowing economic conditions
result in spread widening? Do higher yields provide a sufficient cushion against
downside risk? And is now the time to add fixed income exposure? In our view,
it’s not too late for fixed income investors to take advantage of elevated
yields.

Enhanced breakeven profile for corporate bonds

Source: Aegon Asset Management, Bloomberg as at 31 December 2023. Based on the
ICE BofA Global High Yield Index. Past performance is not a guide to future
performance.

0

5

10

15

20

25

Jan 10

Jan 14

Jan 18

Jan 22

Jan 06

US High Yield index - YTM (%)

Breakeven calculator

Yield rises > 300bps to 11% for negative total return

Yield unchanged = 7.9% return

Yield falls 100bps to 6.9% = 11% return

Breakeven calculator

Yield rises > 100 for negative total return

Yield flat = 5.5% return

Yield falls 100bs for >13% return

0

2

4

6

8

10

Jan 10

Jan 14

Jan 18

Jan 22

Jan 06

US Investment Grade index - YTM (%)

Starting yields have been a reasonable estimate 5 year returns

ICE BofA Global High Yield Index monthly YTW and forward 5 year index returns

24

22

20

18

16

14

%

12

10

8

6

4

2

0

Oct 2002 Tech bubble

May 2007 Pre-GFC tight spreads

Nov 2008 GFC wide spreads

Dec 2009 Post-GFC rally

Dec 2012 Prior to Taper Tantrum

Jan 2016 Energy crisis

13.8

12.9

7.3

22.0

20.8

8.8

9.1

6.1

6.0

8.8

8.4

7.4

Yield to Worst

5 Year Forward Annualised Return (%)

Source: Aegon Asset Management, Bloomberg as at 31 December 2023. Based on the
ICE BofA Global High Yield Index. Past performance is not a guide to future
performance.

Fixed income opportunities: Evaluating spreads vs. yields

Mark Benbow, portfolio manager

Thomas Hanson, head of Europe high yield

Colin Finlayson, portfolio manager

Alex Pelteshki, portfolio manager

CONTRIBUTORS

Why it’s not too late for fixed income investors to take advantage of elevated
yields

RETURN TO HOMEPAGE

The return of bonds

Important information For Professional Clients only and not to be distributed to
or relied upon by retail clients. Past performance is not a guide to future
performance. Opinions and examples represent our understanding of markets: they
are not investment recommendations advice. All data is sourced to Aegon Asset
Management UK plc unless otherwise stated. The document is accurate at the time
of writing but is subject to change without notice. Data attributed to a third
party is proprietary to that third party and is used by Aegon Asset Management
under licence.   Aegon Asset Management UK plc is authorised and regulated by
the Financial Conduct Authority. Adtrax 6105984.1; Expiry 30 April 2025

Fixed Income opportunities: Evaluating spreads vs. yields

OTHER ARTICLES FROM AEGON

Learn more about Aegon Asset Management

“For income-oriented investors, now is the time to consider bonds”

Income is primary driver of returns in the high yield market

Source: Bloomberg, ICE BofA. As of 31 December 2023. Reflects the cumulative
price and income return for the ICE BofA Global High Yield Constrained (HW0C)
index. Past performance is not a guide to future performance.

Enhanced yields across fixed income

Current and historical index yields last 10 years

Yield to worst (%)

12

10

8

6

4

2

0

GO BACK

VIEW MORE

6.76

4.74

4.85

2.42

3.10

0.61

EM HC Aggregate

US Aggregate

Euro Aggregate

2 / 2

Global Aggregate

Global Treasuries

Global Corporates

Global High Yield

3.74

1.64

3.16

1.09

4.88

2.61

8.09

6.22

1 / 2

10 year range

Current

10 year median

Source: Aegon AM, Bloomberg. As at 31 March 2024. Based on Bloomberg indices.
Past performance is not a guide to future performance.

As rates have shifted higher, bond coupons have increased. Investors no longer
need to increase their risk exposure through lower-quality credit to access
attractive coupon rates. Instead, we are uncovering high income opportunities
across the ratings spectrum. BBB and BB bonds now provide a sweet spot for
investors from a risk/return perspective. Companies in this space can still
afford to pay higher coupon rates, but are also better set up to weather a
potential economic slowdown. For high yield investors, higher-quality BB bonds
now offer double-digit coupons; a safer option compared to lower-quality CCC
debt. In our view, this is an opportune time to lock in high coupons in
higher-quality bonds and add steady income.

Opportunities now: Locking in high income in higher-quality bonds

Higher rates provide relatively rare opportunities to pursue enhanced yields and
high income across fixed income markets. However, lingering macro risks and
slowing economic conditions present headwinds. Corporate fundamentals are
showing signs of deterioration amid elevated rates and slowing economic growth.
That said, many companies are starting from a position of strength and are
well-positioned to navigate a slowdown, which should help keep defaults
contained. Tight spreads are also causing some investors to pause. While it is
right to be cautious, it is important to see the bigger picture. It can be
tempting to try time the market and wait for wider spreads to present entry
points. Tactical opportunities may arise, but as the saying goes, it is time in
the market, not timing the market that matters. While spreads could widen, don’t
underestimate the power of carry as income drives fixed income returns over the
long term, particularly at these yields. For income-oriented investors, now is
the time to consider bonds.

Balancing risks and opportunities in fixed income

The total return for bonds consists of income (coupons) and price (capital)
returns. Although price movements are a component, income has been the largest
driver of fixed income total returns over the long term. This steady income, or
carry, from coupons can provide a buffer against price movements. While prices
can be volatile, income provides a steady constant over time. As shown below,
the global high yield index has delivered steady income over the years, despite
price volatility. Higher coupon rates today means bond markets can provide
income that investors are currently demanding from money markets, even when cash
rates decline.

Carry on: Income drives returns in fixed income

As central banks have begun or are expected to start cutting rates, we are
reminded that elevated cash rates won’t last forever. While cash and money
market funds provided steady income in recent years, continuing to hold cash
will eventually prove to be costly as money market rates reset lower and do not
benefit from price appreciation when rates decline. We believe it is time to
consider re-allocating from cash to fixed income. Various segments of the market
currently offer yields at multi-year highs (see below), which provide investors
an attractive alternative to cash in the cutting cycle ahead.

Turning point: High cash rates will fade, look to bonds for elevated yields

Bonds are back with opportunities across the fixed income market. Although cash
and money market funds have delivered steady income in recent years, we believe
that now is the time to seize opportunities in the bond market to add income and
pursue enhanced total returns.

Mark Benbow, portfolio manager

Thomas Hanson, head of Europe high yield

CONTRIBUTORS

Why now is the time to seize opportunities in the bond market to add income and
pursue enhanced total returns

Income opportunities: The case for bonds now

RETURN TO HOMEPAGE

The return of bonds

Important information For Professional Clients only and not to be distributed to
or relied upon by retail clients. Past performance is not a guide to future
performance. Opinions and examples represent our understanding of markets: they
are not investment recommendations advice. All data is sourced to Aegon Asset
Management UK plc unless otherwise stated. The document is accurate at the time
of writing but is subject to change without notice. Data attributed to a third
party is proprietary to that third party and is used by Aegon Asset Management
under licence.   Aegon Asset Management UK plc is authorised and regulated by
the Financial Conduct Authority. Adtrax 6105984.2; Expiry 30 April 2025

Fixed Income opportunities: Evaluating spreads vs. yields

OTHER ARTICLES FROM AEGON

Learn more about Aegon Asset Management

As rates have shifted higher, bond coupons have increased. Investors no longer
need to increase their risk exposure through lower-quality credit to access
attractive coupon rates. Instead, we are uncovering high income opportunities
across the ratings spectrum. BBB and BB bonds now provide a sweet spot for
investors from a risk/return perspective. Companies in this space can still
afford to pay higher coupon rates, but are also better set up to weather a
potential economic slowdown. For high yield investors, higher-quality BB bonds
now offer double-digit coupons; a safer option compared to lower-quality CCC
debt. In our view, this is an opportune time to lock in high coupons in
higher-quality bonds and add steady income.

Opportunities now: Locking in high income in higher-quality bonds

Higher rates provide relatively rare opportunities to pursue enhanced yields and
high income across fixed income markets. However, lingering macro risks and
slowing economic conditions present headwinds. Corporate fundamentals are
showing signs of deterioration amid elevated rates and slowing economic growth.
That said, many companies are starting from a position of strength and are
well-positioned to navigate a slowdown, which should help keep defaults
contained. Tight spreads are also causing some investors to pause. While it is
right to be cautious, it is important to see the bigger picture. It can be
tempting to try time the market and wait for wider spreads to present entry
points. Tactical opportunities may arise, but as the saying goes, it is time in
the market, not timing the market that matters. While spreads could widen, don’t
underestimate the power of carry as income drives fixed income returns over the
long term, particularly at these yields. For income-oriented investors, now is
the time to consider bonds.

Balancing risks and opportunities in fixed income

The total return for bonds consists of income (coupons) and price (capital)
returns. Although price movements are a component, income has been the largest
driver of fixed income total returns over the long term. This steady income, or
carry, from coupons can provide a buffer against price movements. While prices
can be volatile, income provides a steady constant over time. As shown below,
the global high yield index has delivered steady income over the years, despite
price volatility. Higher coupon rates today means bond markets can provide
income that investors are currently demanding from money markets, even when cash
rates decline.

Carry on: Income drives returns in fixed income

As central banks have begun or are expected to start cutting rates, we are
reminded that elevated cash rates won’t last forever. While cash and money
market funds provided steady income in recent years, continuing to hold cash
will eventually prove to be costly as money market rates reset lower and do not
benefit from price appreciation when rates decline. We believe it is time to
consider re-allocating from cash to fixed income. Various segments of the market
currently offer yields at multi-year highs (see below), which provide investors
an attractive alternative to cash in the cutting cycle ahead.

Turning point: High cash rates will fade, look to bonds for elevated yields

Bonds are back with opportunities across the fixed income market. Although cash
and money market funds have delivered steady income in recent years, we believe
that now is the time to seize opportunities in the bond market to add income and
pursue enhanced total returns.

Income is primary driver of returns in the high yield market

Source: Bloomberg, ICE BofA. As of 31 December 2023. Reflects the cumulative
price and income return for the ICE BofA Global High Yield Constrained (HW0C)
index. Past performance is not a guide to future performance.

Enhanced yields across fixed income

Current and historical index yields last 10 years

12

10

8

6

4

2

0

Global Aggregate

Yield to worst (%)

Global Treasuries

Global Corporates

Global High Yield

EM HC Aggregate

US Aggregate

Euro Aggregate

3.74

1.64

3.16

1.09

4.88

2.61

8.09

6.22

6.76

4.74

4.85

2.42

3.10

0.61

10 year range

Current

10 year median

Source: Aegon AM, Bloomberg. As at 31 March 2024. Based on Bloomberg indices.
Past performance is not a guide to future performance.

“For income-oriented investors, now is the time to consider bonds”

Mark Benbow, portfolio manager

Thomas Hanson, head of Europe high yield

CONTRIBUTORS

Income opportunities: The case for bonds now

Why now is the time to seize opportunities in the bond market to add income and
pursue enhanced total returns

RETURN TO HOMEPAGE

The return of bonds

Risk warnings Market volatility risk: The value of the fund and any income from
it can fall or rise because of movements in stockmarkets, currencies and
interest rates, each of which can move irrationally and be affected
unpredictably by diverse factors, including political and economic events. Bond
liquidity risk: The fund holds bonds which could prove difficult to sell. As a
result, the fund may have to lower the selling price, sell other investments or
forego more appealing investment opportunities. Derivatives risk: The fund may
invest in derivatives with the aim of profiting from falling (‘shorting’) as
well as rising prices. Should the asset’s value vary in an unexpected way, the
fund value will reduce. Credit risk: Investments in bonds are affected by
interest rates, inflation and credit ratings. It is possible that bond issuers
will not pay interest or return the capital. All of these events can reduce the
value of bonds held by the fund. Higher-yielding bonds risk: The fund may invest
in higher-yielding bonds, which may increase the risk to capital. Investing in
these types of assets (which are also known as sub-investment grade bonds) can
produce a higher yield but also brings an increased risk of default, which would
affect the capital value of the fund. Charges from capital risk: Where charges
are taken wholly or partly out of a fund's capital, distributable income may be
increased at the expense of capital, which may constrain or erode capital
growth. Emerging markets risk: Compared to more established economies,
investments in emerging markets may be subject to greater volatility due to
differences in generally accepted accounting principles, less governed standards
or from economic or political instability. Under certain market conditions
assets may be difficult to sell. Currency hedging risk: The fund hedges with the
aim of protecting against unwanted changes in foreign exchange rates. The fund
is still subject to market risks, may not be completely protected from all
currency fluctuations and may not be fully hedged at all times. The transaction
costs of hedging may also negatively impact the fund’s returns. ESG risk: The
fund may select, sell or exclude investments based on ESG criteria; this may
lead to the fund underperforming the broader market or other funds that do not
apply ESG criteria. If sold based on ESG criteria rather than solely on
financial considerations, the price obtained might be lower than that which
could have been obtained had the sale not been required. Income risk: The
payment of income and its level is not guaranteed. Please refer to the fund’s
prospectus for full details of these and other risks, including sustainability
risks, which are applicable to this fund.

Important information FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS
AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS.
This is a marketing communication. Before making any final investment decisions,
and to understand the investment risks involved, refer to the fund prospectus,
available in English, and KIID/KID, available in English and in your local
language depending on local country registration, from www.artemisfunds.com or
www.fundinfo.com. CAPITAL AT RISK. All financial investments involve taking risk
and the value of your investment may go down as well as up. This means your
investment is not guaranteed and you may not get back as much as you put in. Any
income from the investment is also likely to vary and cannot be guaranteed.
Investment in a fund concerns the acquisition of units/shares in the fund and
not in the underlying assets of the fund. Reference to specific shares or
companies should not be taken as advice or a recommendation to invest in them.
For information on sustainability-related aspects of a fund, visit
www.artemisfunds.com. The fund is a sub-fund of Artemis Funds (Lux). For further
information, visit www.artemisfunds.com/sicav. For changes made to the Artemis
Funds (Lux) range of Luxembourg-registered funds since launch, visit
www.artemisfunds.com/historic-changes. Third parties (including FTSE and
Morningstar) whose data may be included in this document do not accept any
liability for errors or omissions. For information, visit
www.artemisfunds.com/third-party-data. Any research and analysis in this
communication has been obtained by Artemis for its own use. Although this
communication is based on sources of information that Artemis believes to be
reliable, no guarantee is given as to its accuracy or completeness. Any
forward-looking statements are based on Artemis’ current expectations and
projections and are subject to change without notice. Issued by: Artemis
Investment Management LLP which is authorised and regulated by the UK Financial
Conduct Authority

The ‘acute pain trade’ in UK corporate bonds

OTHER ARTICLES FROM ARTEMIS

Sources 1, 2. BofAML/Bloomberg 3. Company reports, Bloomberg as at 29 December
2023. The index is the ICE BofA Merrill Lynch Global High Yield Constrained
Index 4. BofAML 5. ICE BofA US High Yield Index as at 31 December 2023 6.
Bloomberg as at 31 January 2021 7. Bloomberg, Artemis as at 31 December 2023 8.
As at 01/04/2024 9, 10, 11. ICE BofA indices as at 31 December 20233:.

Learn more about Artemis

For investors who saw the title of this article and assumed it referred to a
high-yield bear market, the good news is that improving economic conditions and
the prospect of falling interest rates make this unlikely. In addition, when
yields from this asset class have been this high in the past (the ICE BofA US
High Yield Index Yield to Worst is currently at 7.5%) , you have had an almost
80% chance of making money over a one-year period if taking a long position .
Over three years, this rises to almost 90% . And in 90% of those periods in
which you ended up in positive territory over three years, you would have made
3.5x as much as you lost in the periods when you ended up out of pocket . Simply
being invested in this asset class at this point should be enough to make a
decent risk-adjusted return over the medium term. But if an opportunity to add
value comes “strutting, gesticulating and moonwalking” into the high-yield
market – well, we think we know where to find it.

8

9

10

11

Jack Holmes is the manager of the Artemis Funds (Lux) – Global High Yield Bond
fund, an actively managed fund that aims to increase the value of shareholders’
investments through a combination of income and capital growth.

The moonwalking bear market

Moving away from the largest issuers is not the only way to obtain an advantage
when it comes to high yield. Taking a genuine global approach can deliver a
similar impact. About 90% of the assets in high-yield funds are in those that
focus on a particular region (mainly the US) . While most of the rest of the
money is in funds that claim to be global, I would argue that in many cases
these are just two regional funds that have been stuck together and rebranded,
managed with little if any reference to one other. Running funds in this way
means overlooking a quirk whereby an international company can issue two bonds
from the same part of the capital structure and with the same maturity, but that
offer different yields depending upon which country they are issued in. Taking
advantage of this mispricing doesn’t involve taking a complex macro view on the
direction of currencies – we simply hedge this risk. But even after this cost is
incurred, it has been possible to earn up to 3 percentage points more over the
past two years by lending to certain companies in euros rather than dollars (and
vice versa) . As the graph below shows, this relationship isn’t consistent and
the prices of the euro/dollar bonds move around a lot. But the small size of our
fund and relative freedom compared with more benchmark-driven approaches let us
flip between the two whenever relative valuations suit. It also highlights that
simple top-down allocation between different currencies won’t capture these
opportunities – these only come about through bottom-up analysis.

6

7

Geographical opportunities

The vast majority of high yield AuM is in funds with a regional approach

Which leads to inefficient pricing opportunities for truly global investors

Source: Bloomberg as at 31 January 2021.

Source: Bloomberg, Artemis as at 31 December 2023. Note: reference to specific
stocks should not be taken as advice or a recommendation to invest in them.

Smaller issuers have tended to outperform over longer time periods, and with
lower drawdowns

Source: ICE BofA US High Yield Index as at 31 December 2023. Note: small =
bottom quartile of total face value issuer sizes; medium = 2nd and 3rd quartile
of total face value issuer sizes; large = top quartile of total face value
issuer sizes

It is important to remember that ‘smaller issuers’ does not mean ‘smaller
companies’. Some have earnings in the billions, and market caps in the tens of
billions, yet they are classed as smaller issuers for the simple reason that
high yield does not account for a significant proportion of their capital stack.

Less analyst coverage makes it easier to gain an informational advantage away
from the largest issuers. But the data shows medium- and smaller-sized issuers
have delivered higher returns than their larger counterparts since the inception
of the global high-yield universe in 1997 . In this way, it is similar to the
small-cap effect in equities over the long term. But that is about as far as the
comparisons go. Whereas with equities, higher-longer term returns from smaller
companies come at the expense of higher volatility, the opposite is true in
high-yield bonds. In the years of the biggest losses for this market – after the
bursting of the dotcom bubble, the Global Financial Crisis and Covid – small
issuers lost less than medium and larger ones .

4

5

Informational advantage

Our view is that while the extreme value available in some areas of the
high-yield bond market may not quite be “strutting, gesticulating and
moonwalking” in front of investors, it is obvious to those whose attention isn’t
focused elsewhere. The global high-yield market is made up of about 1,500
companies which have collectively issued debt worth more than $2trn . Yet of
those 1,500 companies, just 200 account for about half the index by weight .

1

2

Most high-yield funds will focus on this area of the market, either because of
their large size or because they are index-led. In contrast, running
high-conviction funds allows us to focus on what we call ‘the undiscovered
tail’. I recently heard about a major asset manager running a number of large
high-yield funds that won’t allow research resources to be put into issuers that
are less than 10bps of the index. This means they wouldn’t even look at many of
our holdings, such as auctioneer Sotheby’s and miner Perenti. At 3bps and 2bps
of the index respectively, it would be polite to refer to these companies as a
rounding error. In fact, they are not even that.

3

Standout value

Artemis global high yield focuses on the wider market - exploiting the
under-covered and inefficiently priced ‘tail’

100 largest issuers in index account for 36% of total index weight and are focus
of most index-oriented high yield investors; however only c.10% of Artemis Funds
(Lux) Global High Yield Bond

Remainder of fund is non-HY: Non-rated corporates 2.9%: Investment grade: 5.6%
Non-index HY (AT1 and WBS): 5.2%

Source: BofAML, Bloomberg, Artemis as at 31 December 2023.

A minute-long video clip called ‘Awareness Test’ went viral in 2008, racking up
more than 10 million views, due to an editorial sleight of hand that challenged
viewers to test their attention to detail, only to pull the rug from under their
feet. Inviting the viewer to count how many passes were made by a basketball
team, the video showed about 20 seconds of a practice session before revealing
the answer – 13. But it is here where things took a turn for the surreal, when
it asked: “Did you see the moonwalking bear?” The reason for this seemingly
bizarre question was that while the viewers focused on counting the number of
passes, most were completely oblivious to a man dressed in an amateur-looking
bear costume strutting, gesticulating and moonwalking through the middle of the
very basketball session they were supposed to be concentrating on. The message
of the video – released on behalf of Transport for London to promote awareness
of cyclists among road users – was a simple one: “It’s easy to miss something
you’re not looking for”. So, what does this have to do with high-yield bonds?

Have you spotted the ‘moonwalking bear’ of high-yield debt?

Jack Holmes, fund manager

AUTHOR

Smaller issuers in the high-yield market have traditionally returned more than
their larger peers and lost less during times of crisis. So why don’t more funds
hold them?

Risk warnings Market volatility risk: The value of the fund and any income from
it can fall or rise because of movements in stockmarkets, currencies and
interest rates, each of which can move irrationally and be affected
unpredictably by diverse factors, including political and economic events. Bond
liquidity risk: The fund holds bonds which could prove difficult to sell. As a
result, the fund may have to lower the selling price, sell other investments or
forego more appealing investment opportunities. Derivatives risk: The fund may
invest in derivatives with the aim of profiting from falling (‘shorting’) as
well as rising prices. Should the asset’s value vary in an unexpected way, the
fund value will reduce. Credit risk: Investments in bonds are affected by
interest rates, inflation and credit ratings. It is possible that bond issuers
will not pay interest or return the capital. All of these events can reduce the
value of bonds held by the fund. Higher-yielding bonds risk: The fund may invest
in higher-yielding bonds, which may increase the risk to capital. Investing in
these types of assets (which are also known as sub-investment grade bonds) can
produce a higher yield but also brings an increased risk of default, which would
affect the capital value of the fund. Charges from capital risk: Where charges
are taken wholly or partly out of a fund's capital, distributable income may be
increased at the expense of capital, which may constrain or erode capital
growth. Emerging markets risk: Compared to more established economies,
investments in emerging markets may be subject to greater volatility due to
differences in generally accepted accounting principles, less governed standards
or from economic or political instability. Under certain market conditions
assets may be difficult to sell. Currency hedging risk: The fund hedges with the
aim of protecting against unwanted changes in foreign exchange rates. The fund
is still subject to market risks, may not be completely protected from all
currency fluctuations and may not be fully hedged at all times. The transaction
costs of hedging may also negatively impact the fund’s returns. ESG risk: The
fund may select, sell or exclude investments based on ESG criteria; this may
lead to the fund underperforming the broader market or other funds that do not
apply ESG criteria. If sold based on ESG criteria rather than solely on
financial considerations, the price obtained might be lower than that which
could have been obtained had the sale not been required. Income risk: The
payment of income and its level is not guaranteed. Please refer to the fund’s
prospectus for full details of these and other risks, including sustainability
risks, which are applicable to this fund.

Important information FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS
AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS.
This is a marketing communication. Before making any final investment decisions,
and to understand the investment risks involved, refer to the fund prospectus,
available in English, and KIID/KID, available in English and in your local
language depending on local country registration, from www.artemisfunds.com or
www.fundinfo.com. CAPITAL AT RISK. All financial investments involve taking risk
and the value of your investment may go down as well as up. This means your
investment is not guaranteed and you may not get back as much as you put in. Any
income from the investment is also likely to vary and cannot be guaranteed.
Investment in a fund concerns the acquisition of units/shares in the fund and
not in the underlying assets of the fund. Reference to specific shares or
companies should not be taken as advice or a recommendation to invest in them.
For information on sustainability-related aspects of a fund, visit
www.artemisfunds.com. The fund is a sub-fund of Artemis Funds (Lux). For further
information, visit www.artemisfunds.com/sicav. For changes made to the Artemis
Funds (Lux) range of Luxembourg-registered funds since launch, visit
www.artemisfunds.com/historic-changes. Third parties (including FTSE and
Morningstar) whose data may be included in this document do not accept any
liability for errors or omissions. For information, visit
www.artemisfunds.com/third-party-data. Any research and analysis in this
communication has been obtained by Artemis for its own use. Although this
communication is based on sources of information that Artemis believes to be
reliable, no guarantee is given as to its accuracy or completeness. Any
forward-looking statements are based on Artemis’ current expectations and
projections and are subject to change without notice. Issued by: Artemis
Investment Management LLP which is authorised and regulated by the UK Financial
Conduct Authority

Sources 1, 2. BofAML/Bloomberg 3. Company reports, Bloomberg as at 29 December
2023. The index is the ICE BofA Merrill Lynch Global High Yield Constrained
Index 4. BofAML 5. ICE BofA US High Yield Index as at 31 December 2023 6.
Bloomberg as at 31 January 2021 7. Bloomberg, Artemis as at 31 December 2023 8.
As at 01/04/2024 9, 10, 11. ICE BofA indices as at 31 December 20233:.

Learn more about Artemis

The ‘acute pain trade’ in UK corporate bonds

OTHER ARTICLES FROM ARTEMIS

For investors who saw the title of this article and assumed it referred to a
high-yield bear market, the good news is that improving economic conditions and
the prospect of falling interest rates make this unlikely. In addition, when
yields from this asset class have been this high in the past (the ICE BofA US
High Yield Index Yield to Worst is currently at 7.5%) , you have had an almost
80% chance of making money over a one-year period if taking a long position .
Over three years, this rises to almost 90% . And in 90% of those periods in
which you ended up in positive territory over three years, you would have made
3.5x as much as you lost in the periods when you ended up out of pocket . Simply
being invested in this asset class at this point should be enough to make a
decent risk-adjusted return over the medium term. But if an opportunity to add
value comes “strutting, gesticulating and moonwalking” into the high-yield
market – well, we think we know where to find it.

8

9

10

11

Jack Holmes is the manager of the Artemis Funds (Lux) – Global High Yield Bond
fund, an actively managed fund that aims to increase the value of shareholders’
investments through a combination of income and capital growth.

The moonwalking bear market

The vast majority of high yield AuM is in funds with a regional approach

Which leads to inefficient pricing opportunities for truly global investors

Source: Bloomberg as at 31 January 2021.

Source: Bloomberg, Artemis as at 31 December 2023. Note: reference to specific
stocks should not be taken as advice or a recommendation to invest in them.

Moving away from the largest issuers is not the only way to obtain an advantage
when it comes to high yield. Taking a genuine global approach can deliver a
similar impact. About 90% of the assets in high-yield funds are in those that
focus on a particular region (mainly the US) . While most of the rest of the
money is in funds that claim to be global, I would argue that in many cases
these are just two regional funds that have been stuck together and rebranded,
managed with little if any reference to one other. Running funds in this way
means overlooking a quirk whereby an international company can issue two bonds
from the same part of the capital structure and with the same maturity, but that
offer different yields depending upon which country they are issued in. Taking
advantage of this mispricing doesn’t involve taking a complex macro view on the
direction of currencies – we simply hedge this risk. But even after this cost is
incurred, it has been possible to earn up to 3 percentage points more over the
past two years by lending to certain companies in euros rather than dollars (and
vice versa) . As the graph below shows, this relationship isn’t consistent and
the prices of the euro/dollar bonds move around a lot. But the small size of our
fund and relative freedom compared with more benchmark-driven approaches let us
flip between the two whenever relative valuations suit. It also highlights that
simple top-down allocation between different currencies won’t capture these
opportunities – these only come about through bottom-up analysis.

6

7

Geographical opportunities

It is important to remember that ‘smaller issuers’ does not mean ‘smaller
companies’. Some have earnings in the billions, and market caps in the tens of
billions, yet they are classed as smaller issuers for the simple reason that
high yield does not account for a significant proportion of their capital stack.

Less analyst coverage makes it easier to gain an informational advantage away
from the largest issuers. But the data shows medium- and smaller-sized issuers
have delivered higher returns than their larger counterparts since the inception
of the global high-yield universe in 1997 . In this way, it is similar to the
small-cap effect in equities over the long term. But that is about as far as the
comparisons go. Whereas with equities, higher-longer term returns from smaller
companies come at the expense of higher volatility, the opposite is true in
high-yield bonds. In the years of the biggest losses for this market – after the
bursting of the dotcom bubble, the Global Financial Crisis and Covid – small
issuers lost less than medium and larger ones .

4

5

Informational advantage

GO BACK

VIEW MORE

Smaller issuers have tended to outperform over longer time periods, and with
lower drawdowns

2 / 2

1 / 2

Source: ICE BofA US High Yield Index as at 31 December 2023. Note: small =
bottom quartile of total face value issuer sizes; medium = 2nd and 3rd quartile
of total face value issuer sizes; large = top quartile of total face value
issuer sizes.

Our view is that while the extreme value available in some areas of the
high-yield bond market may not quite be “strutting, gesticulating and
moonwalking” in front of investors, it is obvious to those whose attention isn’t
focused elsewhere. The global high-yield market is made up of about 1,500
companies which have collectively issued debt worth more than $2trn . Yet of
those 1,500 companies, just 200 account for about half the index by weight .

1

2

Most high-yield funds will focus on this area of the market, either because of
their large size or because they are index-led. In contrast, running
high-conviction funds allows us to focus on what we call ‘the undiscovered
tail’. I recently heard about a major asset manager running a number of large
high-yield funds that won’t allow research resources to be put into issuers that
are less than 10bps of the index. This means they wouldn’t even look at many of
our holdings, such as auctioneer Sotheby’s and miner Perenti. At 3bps and 2bps
of the index respectively, it would be polite to refer to these companies as a
rounding error. In fact, they are not even that.

3

Standout value

A minute-long video clip called ‘Awareness Test’ went viral in 2008, racking up
more than 10 million views, due to an editorial sleight of hand that challenged
viewers to test their attention to detail, only to pull the rug from under their
feet. Inviting the viewer to count how many passes were made by a basketball
team, the video showed about 20 seconds of a practice session before revealing
the answer – 13. But it is here where things took a turn for the surreal, when
it asked: “Did you see the moonwalking bear?” The reason for this seemingly
bizarre question was that while the viewers focused on counting the number of
passes, most were completely oblivious to a man dressed in an amateur-looking
bear costume strutting, gesticulating and moonwalking through the middle of the
very basketball session they were supposed to be concentrating on. The message
of the video – released on behalf of Transport for London to promote awareness
of cyclists among road users – was a simple one: “It’s easy to miss something
you’re not looking for”. So, what does this have to do with high-yield bonds?

Source: BofAML, Bloomberg, Artemis as at 31 December 2023.

Artemis global high yield focuses on the wider market - exploiting the
under-covered and inefficiently priced ‘tail’

100 largest issuers in index account for 36% of total index weight and are focus
of most index-oriented high yield investors; however only c.10% of Artemis Funds
(Lux) Global High Yield Bond

Remainder of fund is non-HY: Non-rated corporates 2.9%: Investment grade: 5.6%
Non-index HY (AT1 and WBS): 5.2%

Jack Holmes, fund manager

AUTHOR

Smaller issuers in the high-yield market have traditionally returned more than
their larger peers and lost less during times of crisis. So why don’t more funds
hold them?

Have you spotted the ‘moonwalking bear’ of high-yield debt?

RETURN TO HOMEPAGE

The return of bonds

RETURN TO HOMEPAGE

The return of bonds

Important information This information is for investment professionals only and
should not be relied upon by private investors. Past performance is not a
reliable indicator of future returns. Investors should note that the views
expressed may no longer be current and may have already been acted upon. The
value of bonds is influenced by movements in interest rates and bond yields. If
interest rates rise and so bond yields rise, bond prices tend to fall, and vice
versa. The price of bonds with a longer lifetime until maturity is generally
more sensitive to interest rate movements than those with a shorter lifetime to
maturity. The risk of default is based on the issuers ability to make interest
payments and to repay the loan at maturity. Default risk may therefore vary
between government issuers as well as between different corporate issuers. Due
to the greater possibility of default, an investment in a corporate bond is
generally less secure than an investment in government bonds. Fidelity’s range
of fixed income funds can use financial derivative instruments for investment
purposes, which may expose them to a higher degree of risk and can cause
investments to experience larger than average price fluctuations. Reference to
specific securities should not be interpreted as a recommendation to buy or sell
these securities and is only included for illustration purposes. Investments
should be made on the basis of the current prospectus, which is available along
with the Key Investor Information Document (Key Information Document for
Investment Trusts), current annual and semi-annual reports free of charge on
request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised
and regulated by the Financial Conduct Authority. Fidelity International, the
Fidelity International logo and F symbol are trademarks of FIL Limited.
UKM0424/386634/SSO/NA

Learn more about Artemis

Have you spotted the ‘moonwalking bear’ of high-yield debt?

OTHER ARTICLES FROM ARTEMIS

Describing his fund as a “core, bog standard, boring corporate bond fund that
just happens to be doing quite well”, Snowden is positioned for this further
rally in credit spreads. This is most evident in the Duration Times Spread ratio
on the portfolio. This is currently 1.3x on the fund and measures credit
volatility, comparable to equity beta. Though bullish, Snowden is wary about the
presence of persistently high wage inflation. This is something he sees as the
biggest risk facing bond investors over the next year. “The economy continues to
do much better than people think, that allows more confidence in wage
negotiations despite inflation still coming down,” said Snowden. “There is still
that wage bargaining power and to my mind that is the largest risk. “We’re not
pricing in excessive base rate cuts, so if wage inflation continues to be higher
than we think then you’re not looking at a material selloff in bonds – you just
won’t get that capital appreciation.”

A challenging lending environment for UK corporates poses a potential boost for
bond fund managers, with Artemis Head of Fixed Income Stephen Snowden
positioning his strategy to benefit from this ‘acute pain trade’. In a recent
webinar, Snowden explained how many corporates had become accustomed to a low
interest rate environment and the benefits this afforded their debt structures.
This had allowed finance directors to ‘term out’ their debt, changing the
classification of debt on their balance sheets to improve working capital and
take advantage of lower interest rates. Snowden, who manages the £1.4bn Artemis
Corporate Bond Fund, explained how the situation had since changed to benefit
fund managers like him. As well as greater inflows, with fixed income gaining
more attention due to higher yields, this has seen him able to capitalise on
corporates’ disadvantaged position.

“At the very same time as yields are attractive to us to buy, they are
unattractive to the companies to give us those bonds to buy,” said Snowden. “You
have an acute pain trade where if you’ve not set up your fund for a rally, you
get money coming into your fund but very few opportunities in new issues to
reinvest money. That has led to a very acute rally in credit spreads.”
Therefore, Snowden expects the demand for bonds to remain high while supply is
low. The context that supports this demand is corporate bonds are still
out-yielding equities (when comparing the ICE BofA £ Corporate & Collateralised
Index with the FTSE All-Share Dividend Index). This has seen Snowden position
his fund to benefit from the “classic” pain trade. He expects credit spreads,
despite already rallying, to continue to do so: “We have further to go – [this
is supported] by a blend of the fundamental and technical backdrops. Low supply
of corporate bonds, combined with high demand, will drive credit spreads
tighter. “I know it's not the consensus thing to say, but that is what is
happening and that is what is going to happen going forward.”

“We’re not pricing in excessive base rate cuts, so if wage inflation continues
to be higher than we think then you’re not looking at a material selloff in
bonds”

Stephen Snowden, fund manager

“Low supply of corporate bonds, combined with high demand, will drive credit
spreads tighter”

Stephen Snowden, fund manager

Stephen Snowden, fund manager

CONTRIBUTOR

The ‘acute pain trade’ in UK corporate bonds

Restricted supplies of new bonds from companies reluctant to borrow at today’s
higher rates coupled with high demand from investors are creating a powerful
technical backdrop for the corporate bond market

RETURN TO HOMEPAGE

The return of bonds

Important information This information is for investment professionals only and
should not be relied upon by private investors. Past performance is not a
reliable indicator of future returns. Investors should note that the views
expressed may no longer be current and may have already been acted upon. The
value of bonds is influenced by movements in interest rates and bond yields. If
interest rates rise and so bond yields rise, bond prices tend to fall, and vice
versa. The price of bonds with a longer lifetime until maturity is generally
more sensitive to interest rate movements than those with a shorter lifetime to
maturity. The risk of default is based on the issuers ability to make interest
payments and to repay the loan at maturity. Default risk may therefore vary
between government issuers as well as between different corporate issuers. Due
to the greater possibility of default, an investment in a corporate bond is
generally less secure than an investment in government bonds. Fidelity’s range
of fixed income funds can use financial derivative instruments for investment
purposes, which may expose them to a higher degree of risk and can cause
investments to experience larger than average price fluctuations. Reference to
specific securities should not be interpreted as a recommendation to buy or sell
these securities and is only included for illustration purposes. Investments
should be made on the basis of the current prospectus, which is available along
with the Key Investor Information Document (Key Information Document for
Investment Trusts), current annual and semi-annual reports free of charge on
request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised
and regulated by the Financial Conduct Authority. Fidelity International, the
Fidelity International logo and F symbol are trademarks of FIL Limited.
UKM0424/386634/SSO/NA

Learn more about Artemis

Have you spotted the ‘moonwalking bear’ of high-yield debt?

OTHER ARTICLES FROM ARTEMIS

“We’re not pricing in excessive base rate cuts, so if wage inflation continues
to be higher than we think then you’re not looking at a material selloff in
bonds”

Stephen Snowden, fund manager

“Low supply of corporate bonds, combined with high demand, will drive credit
spreads tighter”

Stephen Snowden, fund manager

Describing his fund as a “core, bog standard, boring corporate bond fund that
just happens to be doing quite well”, Snowden is positioned for this further
rally in credit spreads. This is most evident in the Duration Times Spread ratio
on the portfolio. This is currently 1.3x on the fund and measures credit
volatility, comparable to equity beta. Though bullish, Snowden is wary about the
presence of persistently high wage inflation. This is something he sees as the
biggest risk facing bond investors over the next year. “The economy continues to
do much better than people think, that allows more confidence in wage
negotiations despite inflation still coming down,” said Snowden. “There is still
that wage bargaining power and to my mind that is the largest risk. “We’re not
pricing in excessive base rate cuts, so if wage inflation continues to be higher
than we think then you’re not looking at a material selloff in bonds – you just
won’t get that capital appreciation.”

A challenging lending environment for UK corporates poses a potential boost for
bond fund managers, with Artemis Head of Fixed Income Stephen Snowden
positioning his strategy to benefit from this ‘acute pain trade’. In a recent
webinar, Snowden explained how many corporates had become accustomed to a low
interest rate environment and the benefits this afforded their debt structures.
This had allowed finance directors to ‘term out’ their debt, changing the
classification of debt on their balance sheets to improve working capital and
take advantage of lower interest rates. Snowden, who manages the £1.4bn Artemis
Corporate Bond Fund, explained how the situation had since changed to benefit
fund managers like him. As well as greater inflows, with fixed income gaining
more attention due to higher yields, this has seen him able to capitalise on
corporates’ disadvantaged position.

“At the very same time as yields are attractive to us to buy, they are
unattractive to the companies to give us those bonds to buy,” said Snowden. “You
have an acute pain trade where if you’ve not set up your fund for a rally, you
get money coming into your fund but very few opportunities in new issues to
reinvest money. That has led to a very acute rally in credit spreads.”
Therefore, Snowden expects the demand for bonds to remain high while supply is
low. The context that supports this demand is corporate bonds are still
out-yielding equities (when comparing the ICE BofA £ Corporate & Collateralised
Index with the FTSE All-Share Dividend Index). This has seen Snowden position
his fund to benefit from the “classic” pain trade. He expects credit spreads,
despite already rallying, to continue to do so: “We have further to go – [this
is supported] by a blend of the fundamental and technical backdrops. Low supply
of corporate bonds, combined with high demand, will drive credit spreads
tighter. “I know it's not the consensus thing to say, but that is what is
happening and that is what is going to happen going forward.”

Stephen Snowden, fund manager

CONTRIBUTOR

Restricted supplies of new bonds from companies reluctant to borrow at today’s
higher rates coupled with high demand from investors are creating a powerful
technical backdrop for the corporate bond market

The ‘acute pain trade’ in UK corporate bonds

RETURN TO HOMEPAGE

The return of bonds

View our webinar

View our webinar

Important information This information is for investment professionals only and
should not be relied upon by private investors. The value of investments and the
income from them can go down as well as up so you may get back less than you
invest. Past performance is not a reliable indicator of future returns.
Investors should note that the views expressed may no longer be current and may
have already been acted upon. The value of bonds is influenced by movements in
interest rates and bond yields. If interest rates rise and so bond yields rise,
bond prices tend to fall, and vice versa. The price of bonds with a longer
lifetime until maturity is generally more sensitive to interest rate movements
than those with a shorter lifetime to maturity. The risk of default is based on
the issuers ability to make interest payments and to repay the loan at maturity.
Default risk may therefore vary between government issuers as well as between
different corporate issuers. Due to the greater possibility of default, an
investment in a corporate bond is generally less secure than an investment in
government bonds. Fidelity’s range of fixed income funds can use financial
derivative instruments for investment purposes, which may expose them to a
higher degree of risk and can cause investments to experience larger than
average price fluctuations. Reference to specific securities should not be
interpreted as a recommendation to buy or sell these securities and is only
included for illustration purposes. Investments should be made on the basis of
the current prospectus, which is available along with the Key Investor
Information Document (Key Information Document for Investment Trusts), current
annual and semi-annual reports free of charge on request by calling 0800 368
1732. Issued by FIL Pensions Management, authorised and regulated by the
Financial Conduct Authority. Fidelity International, the Fidelity International
logo and F symbol are trademarks of FIL Limited. UKM0424/386634/SSO/NA

Pockets of opportunity in investment grade

OTHER ARTICLES FROM FIDELITY

Learn about the Fidelity Short Dated Corporate Bond Fund

Like its peers, the Fidelity Short Dated Corporate Bond Fund has a low rate of
turnover but it is more active than most. The team on the fund are prepared to
act strategically and the managers are excited about the opportunities an
upcoming period of rate cuts could present. Atkinson and Gohil’s analysts are
already researching strategic trade opportunities in the front end of the yield
curve in anticipation of a potential market dislocation. This is due to what
Atkinson says is the likelihood of “ridiculous valuations” within fixed income
as markets attempt to react accordingly to rate cuts. “One of the things that we
really relish is actually periods of market dislocation because often that's
where you see bonds coming out and they will be trading at ridiculous
valuations,” says Atkinson. “The reason is because when you see volatility in
the markets, you see outflows. With people having to raise cash, the first thing
they often sell is their short-dated bonds because the capital impact is smaller
for them by selling these.” This strategy has served the team well. In previous
rate cutting periods where short-dated debt has outperformed cash, Atkinson says
the fund has been able to gain performance simply from taking advantage of
bondholders being forced to sell. “We have the firepower to take advantage of
that and the credit team who have already done the homework and know the names,”
says Atkinson. “If a broker comes to us and says someone has just hit me with
£10m of XYZ and I can't warehouse this risk, can you take them? In that instance
we can say yes but this is our price. And that is just a culmination of all
those factors that we mentioned, the credit team, the trading desk, having
access to the markets and doing the nuts and bolts of your credit [analysis].”

Taking advantage of market dislocation

This has led markets to price in a number of rate cuts this year. Should rates
fall, the same will happen with the yield on cash and leave holders exposed to
reinvestment risk. In this environment, yield curves may steepen and present new
fixed income opportunities, particularly among short-dated bonds at the front
end. This is where the managers of the £496m Fidelity Short Dated Corporate Bond
Fund, Kris Atkinson and Shamil Gohil, are anticipating the best opportunities.
“By having short-dated bonds you get the benefit of that inverted yield curve
but you also get a little bit of duration,” explains Atkinson. “That duration is
really important when you start to see rates dropping because obviously all
bonds have some degree of reinvestment risk; it just depends on how short
maturity you are. When rates start to fall, that will give you some capital
appreciation at the front end of the curve, and offset any spread widening that
you may or may not see in credit.” There is precedent for this. The managers
point to the last four most recent rate cutting cycles, where in each situation
short-dated credit outperformed cash. While credit risk does increase in these
periods, Gohil reasons that holding good quality debt with a short duration –
often to maturity – provides enough compensation and liquidity. “Effectively,
we're harvesting both the excess credit premium and the liquidity premium, we
get some duration and we don't have much reinvestment risk,” says Gohil. “Based
on a very modest cutting cycle, you can generate decent total returns in an
environment where equities are probably going to be recording single or double
digit drawdowns.”

Caught out by falling rates

After over a decade of near zero interest rates, the return of inflation forced
central banks around the world to raise these. One of the asset classes that
benefited most during this period was cash which began to offer above nominal
yields once again, naturally prompting some investors to increase their
allocations. However, with inflation falling to nearer target levels, the
consensus is that central banks will be more likely to cut rates in 2024 than
sustain them. In the UK, although inflation has still not reached the Bank of
England’s 2% target, stagnating growth and a technical recession are putting
pressure on the Monetary Policy Committee to act.

“One of the things that we really relish is actually periods of market
dislocation because often that's where you see bonds coming out and they will be
trading at ridiculous valuation”

Shamil Gohil, fund manager

“By having short-dated bonds you get the benefit of that inverted yield curve
but you also get a little bit of duration”

Kris Atkinson, fund manager

Short-dated corporate bonds: A natural next step for cash investors

Kris Atkinson, fund manager

Shamil Gohil, fund manager

CONTRIBUTORS

With holders of cash potentially about to be caught out by cuts in interest
rates, why does short-dated fixed income offer a natural home for this capital?

Important information This information is for investment professionals only and
should not be relied upon by private investors. The value of investments and the
income from them can go down as well as up so you may get back less than you
invest. Past performance is not a reliable indicator of future returns.
Investors should note that the views expressed may no longer be current and may
have already been acted upon. The value of bonds is influenced by movements in
interest rates and bond yields. If interest rates rise and so bond yields rise,
bond prices tend to fall, and vice versa. The price of bonds with a longer
lifetime until maturity is generally more sensitive to interest rate movements
than those with a shorter lifetime to maturity. The risk of default is based on
the issuers ability to make interest payments and to repay the loan at maturity.
Default risk may therefore vary between government issuers as well as between
different corporate issuers. Due to the greater possibility of default, an
investment in a corporate bond is generally less secure than an investment in
government bonds. Fidelity’s range of fixed income funds can use financial
derivative instruments for investment purposes, which may expose them to a
higher degree of risk and can cause investments to experience larger than
average price fluctuations. Reference to specific securities should not be
interpreted as a recommendation to buy or sell these securities and is only
included for illustration purposes. Investments should be made on the basis of
the current prospectus, which is available along with the Key Investor
Information Document (Key Information Document for Investment Trusts), current
annual and semi-annual reports free of charge on request by calling 0800 368
1732. Issued by FIL Pensions Management, authorised and regulated by the
Financial Conduct Authority. Fidelity International, the Fidelity International
logo and F symbol are trademarks of FIL Limited. UKM0424/386634/SSO/NA

Pockets of opportunity in investment grade

OTHER ARTICLES FROM FIDELITY

Learn about the Fidelity Short Dated Corporate Bond Fund

“One of the things that we really relish is actually periods of market
dislocation because often that's where you see bonds coming out and they will be
trading at ridiculous valuation”

Shamil Gohil, fund manager

“By having short-dated bonds you get the benefit of that inverted yield curve
but you also get a little bit of duration”

Kris Atkinson, fund manager

Like its peers, the Fidelity Short Dated Corporate Bond Fund has a low rate of
turnover but it is more active than most. The team on the fund are prepared to
act strategically and the managers are excited about the opportunities an
upcoming period of rate cuts could present. Atkinson and Gohil’s analysts are
already researching strategic trade opportunities in the front end of the yield
curve in anticipation of a potential market dislocation. This is due to what
Atkinson says is the likelihood of “ridiculous valuations” within fixed income
as markets attempt to react accordingly to rate cuts. “One of the things that we
really relish is actually periods of market dislocation because often that's
where you see bonds coming out and they will be trading at ridiculous
valuations,” says Atkinson. “The reason is because when you see volatility in
the markets, you see outflows. With people having to raise cash, the first thing
they often sell is their short-dated bonds because the capital impact is smaller
for them by selling these.” This strategy has served the team well. In previous
rate cutting periods where short-dated debt has outperformed cash, Atkinson says
the fund has been able to gain performance simply from taking advantage of
bondholders being forced to sell. “We have the firepower to take advantage of
that and the credit team who have already done the homework and know the names,”
says Atkinson. “If a broker comes to us and says someone has just hit me with
£10m of XYZ and I can't warehouse this risk, can you take them? In that instance
we can say yes but this is our price. And that is just a culmination of all
those factors that we mentioned, the credit team, the trading desk, having
access to the markets and doing the nuts and bolts of your credit [analysis].”

Taking advantage of market dislocation

This has led markets to price in a number of rate cuts this year. Should rates
fall, the same will happen with the yield on cash and leave holders exposed to
reinvestment risk. In this environment, yield curves may steepen and present new
fixed income opportunities, particularly among short-dated bonds at the front
end. This is where the managers of the £496m Fidelity Short Dated Corporate Bond
Fund, Kris Atkinson and Shamil Gohil, are anticipating the best opportunities.
“By having short-dated bonds you get the benefit of that inverted yield curve
but you also get a little bit of duration,” explains Atkinson. “That duration is
really important when you start to see rates dropping because obviously all
bonds have some degree of reinvestment risk; it just depends on how short
maturity you are. When rates start to fall, that will give you some capital
appreciation at the front end of the curve, and offset any spread widening that
you may or may not see in credit.” There is precedent for this. The managers
point to the last four most recent rate cutting cycles, where in each situation
short-dated credit outperformed cash. While credit risk does increase in these
periods, Gohil reasons that holding good quality debt with a short duration –
often to maturity – provides enough compensation and liquidity. “Effectively,
we're harvesting both the excess credit premium and the liquidity premium, we
get some duration and we don't have much reinvestment risk,” says Gohil. “Based
on a very modest cutting cycle, you can generate decent total returns in an
environment where equities are probably going to be recording single or double
digit drawdowns.”

Caught out by falling rates

After over a decade of near zero interest rates, the return of inflation forced
central banks around the world to raise these. One of the asset classes that
benefited most during this period was cash which began to offer above nominal
yields once again, naturally prompting some investors to increase their
allocations. However, with inflation falling to nearer target levels, the
consensus is that central banks will be more likely to cut rates in 2024 than
sustain them. In the UK, although inflation has still not reached the Bank of
England’s 2% target, stagnating growth and a technical recession are putting
pressure on the Monetary Policy Committee to act.

Shamil Gohil, fund manager

Kris Atkinson, fund manager

CONTRIBUTORS

With holders of cash potentially about to be caught out by cuts in interest
rates, why does short-dated fixed income offer a natural home for this capital?

Short-dated corporate bonds: A natural next step for cash investors

RETURN TO HOMEPAGE

The return of bonds

RETURN TO HOMEPAGE

The return of bonds

Important information This information is for investment professionals only and
should not be relied upon by private investors. The value of investments and the
income from them can go down as well as up so you may get back less than you
invest. Past performance is not a reliable indicator of future returns.
Investors should note that the views expressed may no longer be current and may
have already been acted upon. The value of bonds is influenced by movements in
interest rates and bond yields. If interest rates rise and so bond yields rise,
bond prices tend to fall, and vice versa. The price of bonds with a longer
lifetime until maturity is generally more sensitive to interest rate movements
than those with a shorter lifetime to maturity. The risk of default is based on
the issuers ability to make interest payments and to repay the loan at maturity.
Default risk may therefore vary between government issuers as well as between
different corporate issuers. Due to the greater possibility of default, an
investment in a corporate bond is generally less secure than an investment in
government bonds. Fidelity’s range of fixed income funds can use financial
derivative instruments for investment purposes, which may expose them to a
higher degree of risk and can cause investments to experience larger than
average price fluctuations. Reference to specific securities should not be
interpreted as a recommendation to buy or sell these securities and is only
included for illustration purposes. Investments should be made on the basis of
the current prospectus, which is available along with the Key Investor
Information Document (Key Information Document for Investment Trusts), current
annual and semi-annual reports free of charge on request by calling 0800 368
1732. Issued by FIL Pensions Management, authorised and regulated by the
Financial Conduct Authority. Fidelity International, the Fidelity International
logo and F symbol are trademarks of FIL Limited. UKM0424/386634/SSO/NA

Short-dated corporate bonds: A natural next step for cash investors

OTHER ARTICLES FROM FIDELITY

Learn about the Fidelity Short Dated Corporate Bond Fund

Conversely, Atkinson and Gohil are limiting their exposure to sectors that may
be more vulnerable to recession in 2024. This includes commodity-focused names
and sectors exposed to consumer behaviour. Banks and real estate are included in
this by the managers, but there are still seeing opportunities within these,
despite their vulnerability to economic volatility. The managers benefit from a
deep analyst bench and are able to be selective, separating strong names from
the weak within both sectors. “Where we do have exposure in banks, and you have
to own some as it's a big part of our universe, we tend to focus on the big,
solid banks,” says Atkinson, making a clear demarcation from smaller banks with
less capital or more concentrated loan books. “Where we do have bank exposure
it's high quality again because it's not much to give up in owning that and you
own much more liquid parts of the market there.” Likewise, within real estate
Atkinson and Gohil have been discerning and opted for the defensive areas of the
sector – with residential and logistics being two key examples – instead of
office and retail sites. “Again, it's issuer selection,” adds Gohil. “A lot of
these companies have been oversold, are cheap and are doing the right thing. As
a broad brush, that sector has just been unloved for a while. We are starting to
see that reverse now, which has benefited our performance.”

Issuer-specific opportunities

The high cost of debt refinancing is hitting some companies hard, especially
within the SME space where insolvencies have increased. This has highlighted the
importance of quality, with Atkinson and Gohil preferring to hold investment
grade names against this backdrop. The managers have focused on defensive
sectors and particularly those backed by physical assets, such as property or
utilities, that can underpin valuations. The pair have made these moves mindful
of upcoming volatility from monetary policy in the UK. Though not bearish, Gohil
points to a potential “policy error” from high rates being sustained for too
long and the potential repercussions of this. “UK growth is stagnating, and we
don’t really have much headroom there in terms of holding rates for much
longer,” says Gohil, who explains they are targeting high quality companies that
are better placed to “weather that storm”. Within investment grade, this has
included regulated utilities like water which offers inflation protection
qualities despite current negative publicity. “Given all the headlines we've
seen in the press around the water sector, that is having a knock-on impact in
the markets and creating a sector which is recession proof, inflation proof,
highly regulated and pretty cheap,” explains Gohil. “We accept that we're going
to have to hold our noses and tolerate some daily headlines from various parts
of the media but that's something that we think is particularly attractive.”

Preparing for the storm

Despite becoming more expensive, investment grade debt could present
opportunities for fixed income investors against a backdrop of higher rates.
With higher rates, many investors have gravitated towards high yield debt and
shunned investment grade names. However, companies in the latter category have
been able to benefit and generate higher revenues during this period. Many of
these companies were also able to raise finance with tight coupons during the
years of quantitative easing, leaving them with surplus liquidity. And unlike
high yield companies, these corporates have been able to earn more on their cash
balances. This is why the managers of the £496m Fidelity Short Dated Corporate
Bond Fund, Kris Atkinson and Shamil Gohil, are seeing the best opportunities in
investment grade debt. Atkinson points to the example of two differently rated
issuers in the same industry. “Imagine you had a supermarket that was a B-rated
issuer - most of its debt historically has been around the 4% mark and they
refinanced at 10%ish,” says Atkinson. “You very quickly can see how their cost
of funding spiked. “Then you look at investment grade competing supermarket.
Their cost of funding has gone up by a similar order of magnitude, but from a
couple of percent to probably 5% or 6%. And that's on 7% of their debt stack. It
will take a lot longer for them to feel the impact of higher rates.”

“It’s issuer selection. A lot of these companies have been oversold, are cheap
and are doing the right thing”

Shamil Gohil, fund manager

“Given all the headlines we've seen in the press around the water sector, that
is having a knock-on impact in the markets and creating a sector which is
recession proof, inflation proof, highly regulated and pretty cheap”

Shamil Gohil, fund manager

Pockets of opportunity in investment grade

Kris Atkinson, fund manager

Shamil Gohil, fund manager

CONTRIBUTORS

With rate cuts looking increasingly likely, could fixed income investors benefit
from holding higher rated debt?

Important information This information is for investment professionals only and
should not be relied upon by private investors. The value of investments and the
income from them can go down as well as up so you may get back less than you
invest. Past performance is not a reliable indicator of future returns.
Investors should note that the views expressed may no longer be current and may
have already been acted upon. The value of bonds is influenced by movements in
interest rates and bond yields. If interest rates rise and so bond yields rise,
bond prices tend to fall, and vice versa. The price of bonds with a longer
lifetime until maturity is generally more sensitive to interest rate movements
than those with a shorter lifetime to maturity. The risk of default is based on
the issuers ability to make interest payments and to repay the loan at maturity.
Default risk may therefore vary between government issuers as well as between
different corporate issuers. Due to the greater possibility of default, an
investment in a corporate bond is generally less secure than an investment in
government bonds. Fidelity’s range of fixed income funds can use financial
derivative instruments for investment purposes, which may expose them to a
higher degree of risk and can cause investments to experience larger than
average price fluctuations. Reference to specific securities should not be
interpreted as a recommendation to buy or sell these securities and is only
included for illustration purposes. Investments should be made on the basis of
the current prospectus, which is available along with the Key Investor
Information Document (Key Information Document for Investment Trusts), current
annual and semi-annual reports free of charge on request by calling 0800 368
1732. Issued by FIL Pensions Management, authorised and regulated by the
Financial Conduct Authority. Fidelity International, the Fidelity International
logo and F symbol are trademarks of FIL Limited. UKM0424/386634/SSO/NA

Short-dated corporate bonds: A natural next step for cash investors

OTHER ARTICLES FROM FIDELITY

Learn about the Fidelity Short Dated Corporate Bond Fund

“It’s issuer selection. A lot of these companies have been oversold, are cheap
and are doing the right thing”

Shamil Gohil, fund manager

“Given all the headlines we've seen in the press around the water sector, that
is having a knock-on impact in the markets and creating a sector which is
recession proof, inflation proof, highly regulated and pretty cheap”

Shamil Gohil, fund manager

Conversely, Atkinson and Gohil are limiting their exposure to sectors that may
be more vulnerable to recession in 2024. This includes commodity-focused names
and sectors exposed to consumer behaviour. Banks and real estate are included in
this by the managers, but there are still seeing opportunities within these,
despite their vulnerability to economic volatility. The managers benefit from a
deep analyst bench and are able to be selective, separating strong names from
the weak within both sectors. “Where we do have exposure in banks, and you have
to own some as it's a big part of our universe, we tend to focus on the big,
solid banks,” says Atkinson, making a clear demarcation from smaller banks with
less capital or more concentrated loan books. “Where we do have bank exposure
it's high quality again because it's not much to give up in owning that and you
own much more liquid parts of the market there.” Likewise, within real estate
Atkinson and Gohil have been discerning and opted for the defensive areas of the
sector – with residential and logistics being two key examples – instead of
office and retail sites. “Again, it's issuer selection,” adds Gohil. “A lot of
these companies have been oversold, are cheap and are doing the right thing. As
a broad brush, that sector has just been unloved for a while. We are starting to
see that reverse now, which has benefited our performance.”

Issuer-specific opportunities

The high cost of debt refinancing is hitting some companies hard, especially
within the SME space where insolvencies have increased. This has highlighted the
importance of quality, with Atkinson and Gohil preferring to hold investment
grade names against this backdrop. The managers have focused on defensive
sectors and particularly those backed by physical assets, such as property or
utilities, that can underpin valuations. The pair have made these moves mindful
of upcoming volatility from monetary policy in the UK. Though not bearish, Gohil
points to a potential “policy error” from high rates being sustained for too
long and the potential repercussions of this. “UK growth is stagnating, and we
don’t really have much headroom there in terms of holding rates for much
longer,” says Gohil, who explains they are targeting high quality companies that
are better placed to “weather that storm”. Within investment grade, this has
included regulated utilities like water which offers inflation protection
qualities despite current negative publicity. “Given all the headlines we've
seen in the press around the water sector, that is having a knock-on impact in
the markets and creating a sector which is recession proof, inflation proof,
highly regulated and pretty cheap,” explains Gohil. “We accept that we're going
to have to hold our noses and tolerate some daily headlines from various parts
of the media but that's something that we think is particularly attractive.”

Preparing for the storm

Despite becoming more expensive, investment grade debt could present
opportunities for fixed income investors against a backdrop of higher rates.
With higher rates, many investors have gravitated towards high yield debt and
shunned investment grade names. However, companies in the latter category have
been able to benefit and generate higher revenues during this period. Many of
these companies were also able to raise finance with tight coupons during the
years of quantitative easing, leaving them with surplus liquidity. And unlike
high yield companies, these corporates have been able to earn more on their cash
balances. This is why the managers of the £496m Fidelity Short Dated Corporate
Bond Fund, Kris Atkinson and Shamil Gohil, are seeing the best opportunities in
investment grade debt. Atkinson points to the example of two differently rated
issuers in the same industry. “Imagine you had a supermarket that was a B-rated
issuer - most of its debt historically has been around the 4% mark and they
refinanced at 10%ish,” says Atkinson. “You very quickly can see how their cost
of funding spiked. “Then you look at investment grade competing supermarket.
Their cost of funding has gone up by a similar order of magnitude, but from a
couple of percent to probably 5% or 6%. And that's on 7% of their debt stack. It
will take a lot longer for them to feel the impact of higher rates.”

Shamil Gohil, fund manager

Kris Atkinson, fund manager

CONTRIBUTORS

With rate cuts looking increasingly likely, could fixed income investors benefit
from holding higher rated debt?

Pockets of opportunity in investment grade

RETURN TO HOMEPAGE

The return of bonds

RETURN TO HOMEPAGE

The return of bonds

For Professional Investors only. All investments involve risk, including the
possible loss of capital. In the United Kingdom, information is issued by PGIM
Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square,
London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial
Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418),
and with respect to its Italian operations by the Consob and Bank of Italy. In
the European Economic Area (“EEA”), information may be issued by PGIM
Netherlands B.V., PGIM Limited or PGIM Luxembourg S.A. depending on the
jurisdiction. PGIM Netherlands B.V., with registered office at Gustav Mahlerlaan
1212, 1081 LA, Amsterdam, The Netherlands, is authorised by the Autoriteit
Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and
operates on the basis of a European passport. FOR IMPORTANT INFORMATION RELATED
TO RISKS AND DISCLOSURES PLEASE VISIT PGIM.COM/UCITS/DISCLOSURE. © 2024
Prudential Financial, Inc. (PFI) and its related entities. PFI of the United
States is not affiliated with Prudential plc, incorporated in the United Kingdom
or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in
the United Kingdom. PGIM and the PGIM logo are service marks of PFI and its
related entities, registered in many jurisdictions worldwide. 3475038.

Strike the right balance with bonds at PGIMFunds.com

Investor sentiment appears to suggest otherwise, but a recession is still a
distinct possibility for the world’s largest economy. Perhaps investors envision
a scenario that, although slightly less likely, remains plausible, such as an
exceptionally uneventful soft landing. According to Gregory Peters, co-chief
investment officer at PGIM Fixed Income, the highest-probability outcome is
somewhere in between, which he considers to be good news for bond investors. Key
features in this model macro scenario include inflation that runs above target
without being disruptive and below-trend growth that still fosters an
environment with room for spending on technology, research and manufacturing
capacity to expand. Moreover, at current levels, yields offer bond investors a
level of protection not seen in years. In the accompanying video, Peters
explains how these conditions should shape the monetary policy picture and why,
when he assesses the 2024 market backdrop, he sees ‘a great opportunity for
fixed income.’

Fixed income returns to prominence

OTHER ARTICLES FROM PGIM

Why bonds are in a buy zone

Gregory Peters, co-chief investment officer, PGIM Fixed Income

CONTRIBUTOR

Inflation that runs above target without being disruptive and below-trend growth
that leaves room for corporate spending could offer a great opportunity for
fixed income

For Professional Investors only. All investments involve risk, including the
possible loss of capital. In the United Kingdom, information is issued by PGIM
Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square,
London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial
Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418),
and with respect to its Italian operations by the Consob and Bank of Italy. In
the European Economic Area (“EEA”), information may be issued by PGIM
Netherlands B.V., PGIM Limited or PGIM Luxembourg S.A. depending on the
jurisdiction. PGIM Netherlands B.V., with registered office at Gustav Mahlerlaan
1212, 1081 LA, Amsterdam, The Netherlands, is authorised by the Autoriteit
Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and
operates on the basis of a European passport. FOR IMPORTANT INFORMATION RELATED
TO RISKS AND DISCLOSURES PLEASE VISIT PGIM.COM/UCITS/DISCLOSURE. © 2024
Prudential Financial, Inc. (PFI) and its related entities. PFI of the United
States is not affiliated with Prudential plc, incorporated in the United Kingdom
or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in
the United Kingdom. PGIM and the PGIM logo are service marks of PFI and its
related entities, registered in many jurisdictions worldwide. 3475038.

Strike the right balance with bonds at PGIMFunds.com

Investor sentiment appears to suggest otherwise, but a recession is still a
distinct possibility for the world’s largest economy. Perhaps investors envision
a scenario that, although slightly less likely, remains plausible, such as an
exceptionally uneventful soft landing. According to Gregory Peters, co-chief
investment officer at PGIM Fixed Income, the highest-probability outcome is
somewhere in between, which he considers to be good news for bond investors. Key
features in this model macro scenario include inflation that runs above target
without being disruptive and below-trend growth that still fosters an
environment with room for spending on technology, research and manufacturing
capacity to expand. Moreover, at current levels, yields offer bond investors a
level of protection not seen in years. In the accompanying video, Peters
explains how these conditions should shape the monetary policy picture and why,
when he assesses the 2024 market backdrop, he sees ‘a great opportunity for
fixed income.’

Fixed income returns to prominence

OTHER ARTICLES FROM PGIM

Gregory Peters, co-chief investment officer, PGIM Fixed Income

CONTRIBUTOR

Inflation that runs above target without being disruptive and below-trend growth
that leaves room for corporate spending could offer a great opportunity for
fixed income

Why bonds are in a buy zone

RETURN TO HOMEPAGE

The return of bonds

RETURN TO HOMEPAGE

The return of bonds

For Professional Investors only. All investments involve risk, including the
possible loss of capital. Risks: An investment in the Fund involve a high degree
of risk, including the risk that the entire amount invested may be lost. The
Fund are primarily designed to purchase certain investments, which will
introduce significant risk to the Fund, including asset performance, price
volatility, administrative risk and counterparty risk. No guarantee or
representation is made that any fund’s investment program will be successful, or
that such fund’s returns will exhibit low correlation with an investor’s
traditional securities portfolio. In the United Kingdom, information is issued
by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar
Square, London, WC2N 5HR. PGIM Limited is authorised and regulated by the
Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number
193418), and with respect to its Italian operations by the Consob and Bank of
Italy. In the European Economic Area (“EEA”), information may be issued by PGIM
Netherlands B.V., PGIM Limited or PGIM Luxembourg S.A. depending on the
jurisdiction. PGIM Netherlands B.V., with registered office at Gustav Mahlerlaan
1212, 1081 LA, Amsterdam, The Netherlands, is authorised by the Autoriteit
Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and
operates on the basis of a European passport. The Fund is a sub-fund of PGIM
Funds plc. An investor must review the Fund’s prospectus, supplement and Key
Investor Information Document (“KIID”) or Key Information Document (the “KID”),
depending on the jurisdiction (together, the “Fund Documents”) before making a
decision to invest. The Fund Documents are available at PGIM Limited, 1-3 The
Strand, Grand Buildings, Trafalgar Square, London, WC2N 5HR, PGIM Netherlands
B.V., Gustav Mahlerlaan 1212, 1081 LA, Amsterdam, and/or PGIM Luxembourg S.A.,
2, boulevard de la Foire, L-1528 Luxembourg, or at www.pgimfunds.com. The
information herein is for informational or educational purposes. The information
is not intended as investment advice and is not a recommendation about managing
or investing assets. In providing these materials, PGIM is not acting as your
fiduciary. FOR IMPORTANT INFORMATION RELATED TO RISKS AND DISCLOSURES PLEASE
VISIT PGIM.COM/UCITS/DISCLOSURE. © 2024 Prudential Financial, Inc. (PFI) and its
related entities. PFI of the United States is not affiliated with Prudential
plc, incorporated in the United Kingdom or with Prudential Assurance Company, a
subsidiary of M&G plc, incorporated in the United Kingdom. PGIM and the PGIM
logo are service marks of PFI and its related entities, registered in many
jurisdictions worldwide. 3475038.

Strike the right balance with bonds at PGIMFunds.com

Why bonds are in a buy zone

OTHER ARTICLES FROM PGIM

As a leading active global asset manager, PGIM Fixed Income can help investors
navigate and analyse complex bond markets. Local expertise combined with deep
credit research resources across bond sectors and regions help uncover value and
deliver long-term returns. ‘We are a bottom-up manager with deep credit
management expertise,’ Peters said, ‘and we’re finding many great opportunities
in today’s fixed income environment.’

Analysing opportunities with an active fixed income leader

High yield bonds sit high on this list. Many fixed income investors remained on
the sidelines in this sector in recent years, expecting a recession in 2023 that
never arrived. This led to underweight high yield allocations in their
portfolios, a situation that Peters said is changing. ‘Global high yield is
seeing some inflows as investors realise that the risk of recession is coming
down meaningfully,’ Peters said. Most forecasts expect new high yield bond
issuance between $170 billion and $230 billion (USD) in 2024, which Peters views
as manageable considering the $1.35 trillion size of the market. Investors can
find dispersion opportunities these days in both B-rated and CCC-rated bonds, he
said. With recession fears fading, Peters sees defaults in the high yield sector
remaining contained at 3.5% over the next 12 months. He noted that many issuers
have de-levered their balance sheets and are waiting to refinance their debt,
creating a full pipeline of potential improvements to investment-grade ratings.
‘We see areas of value in high yield,’ Peters said. ‘It’s a very different
picture versus 10 years ago.’

Pivoting toward high yield

In addition to high yield bonds, PGIM Fixed Income is finding value in
securitised credit, particularly at the top of the capital structure, as well as
in select investment-grade corporate bond sectors such as banks and pipelines.
Peters cautioned investors to be careful and tactical about duration and curve
risk because the yield curve remains inverted. While many investors have parked
significant assets in cash in recent years to benefit from higher yields, Peters
noted that cash yields will likely fall when central banks cut interest rates
while bonds should offer alpha opportunities for investors focusing on relative
value analysis.

Seeking value across the fixed income spectrum

Inflation is easing and the U.S. Federal Reserve is signaling rate cuts this
year. While markets are pricing in these anticipated cuts and some economists
are expecting a return to rock-bottom rates, PGIM Fixed Income sees bond yields
stabilising at elevated levels but still offering investors long-term
opportunities. ‘We think there’s room for the Fed to modulate rates lower and
keep policy restrictive, yet we don’t see the federal funds rate dipping down to
historical pre-Covid low levels,’ said Gregory Peters, co-chief investment
officer at PGIM Fixed Income and portfolio manager of the PGIM Multi Asset
Credit Fund. ‘Zero interest rate policy and negative rates are a relic of the
past.’ PGIM Fixed Income’s base case for the U.S. economy is ‘weakflation’—a
combination of sluggish growth and declining inflation that still hovers above
the Fed’s 2% target rate—with recession still a possibility. The 10-year U.S.
Treasury yield likely will remain in a long-term range between 3% and 5%.
However the economic scenario plays out, Peters sees significant opportunities
across multiple fixed income sectors.

“We see areas of value in high yield. It’s a very different picture versus 10
years ago”

Gregory Peters, co-chief investment officer, PGIM Fixed Income

Fixed income returns to prominence

Gregory Peters, co-chief investment officer, PGIM Fixed Income

CONTRIBUTOR

Elevated yields and the end of central bank rate-hiking cycles may generate
alpha opportunities when viewing bonds through a relative value lens

For Professional Investors only. All investments involve risk, including the
possible loss of capital. In the United Kingdom, information is issued by PGIM
Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square,
London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial
Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418),
and with respect to its Italian operations by the Consob and Bank of Italy. In
the European Economic Area (“EEA”), information may be issued by PGIM
Netherlands B.V., PGIM Limited or PGIM Luxembourg S.A. depending on the
jurisdiction. PGIM Netherlands B.V., with registered office at Gustav Mahlerlaan
1212, 1081 LA, Amsterdam, The Netherlands, is authorised by the Autoriteit
Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and
operates on the basis of a European passport. FOR IMPORTANT INFORMATION RELATED
TO RISKS AND DISCLOSURES PLEASE VISIT PGIM.COM/UCITS/DISCLOSURE. © 2024
Prudential Financial, Inc. (PFI) and its related entities. PFI of the United
States is not affiliated with Prudential plc, incorporated in the United Kingdom
or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in
the United Kingdom. PGIM and the PGIM logo are service marks of PFI and its
related entities, registered in many jurisdictions worldwide. 3475038.

Why bonds are in a buy zone

OTHER ARTICLES FROM PGIM

Strike the right balance with bonds at PGIMFunds.com

“We see areas of value in high yield. It’s a very different picture versus 10
years ago”

Gregory Peters, co-chief investment officer, PGIM Fixed Income

As a leading active global asset manager, PGIM Fixed Income can help investors
navigate and analyse complex bond markets. Local expertise combined with deep
credit research resources across bond sectors and regions help uncover value and
deliver long-term returns. ‘We are a bottom-up manager with deep credit
management expertise,’ Peters said, ‘and we’re finding many great opportunities
in today’s fixed income environment.’

Analysing opportunities with an active fixed income leader

High yield bonds sit high on this list. Many fixed income investors remained on
the sidelines in this sector in recent years, expecting a recession in 2023 that
never arrived. This led to underweight high yield allocations in their
portfolios, a situation that Peters said is changing. ‘Global high yield is
seeing some inflows as investors realise that the risk of recession is coming
down meaningfully,’ Peters said. Most forecasts expect new high yield bond
issuance between $170 billion and $230 billion (USD) in 2024, which Peters views
as manageable considering the $1.35 trillion size of the market. Investors can
find dispersion opportunities these days in both B-rated and CCC-rated bonds, he
said. With recession fears fading, Peters sees defaults in the high yield sector
remaining contained at 3.5% over the next 12 months. He noted that many issuers
have de-levered their balance sheets and are waiting to refinance their debt,
creating a full pipeline of potential improvements to investment-grade ratings.
‘We see areas of value in high yield,’ Peters said. ‘It’s a very different
picture versus 10 years ago.’

Pivoting toward high yield

In addition to high yield bonds, PGIM Fixed Income is finding value in
securitised credit, particularly at the top of the capital structure, as well as
in select investment-grade corporate bond sectors such as banks and pipelines.
Peters cautioned investors to be careful and tactical about duration and curve
risk because the yield curve remains inverted. While many investors have parked
significant assets in cash in recent years to benefit from higher yields, Peters
noted that cash yields will likely fall when central banks cut interest rates
while bonds should offer alpha opportunities for investors focusing on relative
value analysis.

Seeking value across the fixed income spectrum

Inflation is easing and the U.S. Federal Reserve is signaling rate cuts this
year. While markets are pricing in these anticipated cuts and some economists
are expecting a return to rock-bottom rates, PGIM Fixed Income sees bond yields
stabilising at elevated levels but still offering investors long-term
opportunities. ‘We think there’s room for the Fed to modulate rates lower and
keep policy restrictive, yet we don’t see the federal funds rate dipping down to
historical pre-Covid low levels,’ said Gregory Peters, co-chief investment
officer at PGIM Fixed Income and portfolio manager of the PGIM Multi Asset
Credit Fund. ‘Zero interest rate policy and negative rates are a relic of the
past.’ PGIM Fixed Income’s base case for the U.S. economy is ‘weakflation’—a
combination of sluggish growth and declining inflation that still hovers above
the Fed’s 2% target rate—with recession still a possibility. The 10-year U.S.
Treasury yield likely will remain in a long-term range between 3% and 5%.
However the economic scenario plays out, Peters sees significant opportunities
across multiple fixed income sectors.

Gregory Peters, co-chief investment officer, PGIM Fixed Income

CONTRIBUTOR

Elevated yields and the end of central bank rate-hiking cycles may generate
alpha opportunities when viewing bonds through a relative value lens

Fixed income returns to prominence

RETURN TO HOMEPAGE

The return of bonds

RETURN TO HOMEPAGE

The return of bonds

RETURN TO HOMEPAGE

THE RETURN OF BONDS




Fixed income opportunities: Evaluating spreads vs. yields




Why it’s not too late for fixed income investors to take advantage of elevated
yields



CONTRIBUTORS



Colin Finlayson, portfolio manager



Alex Pelteshki, portfolio manager



Mark Benbow, portfolio manager



Thomas Hanson, head of Europe high yield

Rising rates have led to attractive yields across the fixed income market.
However, corporate credit spreads are tight. This leaves many investors
grappling with the valuations conundrum, as they debate yields versus spreads to
determine their fixed income allocations. Will slowing economic conditions
result in spread widening? Do higher yields provide a sufficient cushion against
downside risk? And is now the time to add fixed income exposure? In our view,
it’s not too late for fixed income investors to take advantage of elevated
yields.

Spreads have narrowed, but yields remain attractive

Corporate bond spreads have narrowed to lows not seen since 2022. As the cycle
extends and economy slows, it is no wonder investors are starting to worry about
potential spread widening given the upside for capital returns is now more
limited. However, the attractiveness of asset classes can be evaluated using
various metrics including yields, spreads, expected returns, etc. Many fixed
income assets offer higher yields than has been normal in the last decade. Fixed
income also offers enhanced income as coupon rates have reset higher. While
spread levels look less compelling, all-in yields and higher coupons remain
attractive.




Past performance doesn’t predict future returns, but can yields?

Although spreads are tight, investors mustn’t lose sight of the bigger picture.
Over the long term, the starting yield has been a steady indicator of future
long-term total returns. As shown below, the starting yield-to-worst for the
high yield index has been close to the subsequent annualised five-year return.
This relationship has generally held true in strong and weak economic
environments, as well as periods with tight and wide spreads, With high yield
corporate bonds offering a starting yield to worst around 7.7%, we continue to
like the asset class on a yield basis.



Starting yields have been a reasonable estimate 5 year returns

ICE BofA Global High Yield Index monthly YTW and forward 5 year index returns

24

22

20

18

16

%

14

12

10

8

6

4

2

0




Oct 2002 Tech bubble

May 2007 Pre-GFC tight spreads

Nov 2008 GFC wide spreads

Dec 2009 Post-GFC rally

Dec 2012 Prior to Taper Tantrum

Jan 2016 Energy crisis

22.0

20.8

13.8

12.9

9.1

8.8

8.8

8.4

7.4

7.3

6.1

6.0

Yield to Worst



5 Year Forward Annualised Return (%)










Source: Aegon Asset Management, Bloomberg as at 31 December 2023. Based on the
ICE BofA Global High Yield Index. Past performance is not a guide to future
performance.



Enhanced breakeven rates

Even if spreads or yields widen from here, the breakeven rate for bonds is now
considerably more attractive. The breakeven rate measures how high yields (or
spreads) would need to rise before the total return of a bond becomes negative,
typically over a one year time horizon. The total return of a bond has two
components: price return and income return from coupon payments. Prior to 2022,
there was little income or yield available from newly issued bonds as markets
had a prolonged period of low interest rates. However, as rates have shifted
higher, yields across fixed income have risen and newly issued debt now offers
higher coupon rates. Therefore, bond prices can now fall by a much greater
degree before the total return becomes negative. For example, the yield on the
US High Yield Bond Index can rise from the current level of 7.9% to over 10% -
through wider spreads and/or higher core yields - before total returns break
even. For US investment grade, yields can widen by 100 bps before investors lose
money. This cushion is the biggest it has been for over a decade.

Enhanced breakeven profile for corporate bonds

US Investment Grade index - YTM (%)

10




8



6



4



2



0



Jan 06

Jan 10

Jan 14

Jan 18

Jan 22




Breakeven calculator

Yield rises > 100 for negative total return




Yield flat = 5.5% return



Yield falls 100bs for >13% return

US High Yield index - YTM (%)

25




20



15



10



5



0



Jan 06

Jan 10

Jan 14

Jan 18

Jan 22




Breakeven calculator

Yield rises > 300bps to 11% for negative total return



Yield unchanged = 7.9% return




Yield falls 100bps to 6.9% = 11% return



Source: Aegon Asset Management, Bloomberg as at 31 December 2023. Based on the
ICE BofA Global High Yield Index. Past performance is not a guide to future
performance.



While there are attractive opportunities for fixed income investors to take
advantage of current yields, we are cognisant that risks remain. While not our
base case, reacceleration in inflation or a deeper-than-expected recession,
could impact future returns. Therefore, an active management approach is
necessary to navigate fixed income markets.



Learn more about Aegon Asset Management

OTHER ARTICLES FROM AEGON



Income opportunities: the case for bonds now




Important information For Professional Clients only and not to be distributed to
or relied upon by retail clients. Past performance is not a guide to future
performance. Opinions and examples represent our understanding of markets: they
are not investment recommendations advice. All data is sourced to Aegon Asset
Management UK plc unless otherwise stated. The document is accurate at the time
of writing but is subject to change without notice. Data attributed to a third
party is proprietary to that third party and is used by Aegon Asset Management
under licence.   Aegon Asset Management UK plc is authorised and regulated by
the Financial Conduct Authority. Adtrax 6105984.1; Expiry 30 April 2025



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present

The return of bonds

Where are the best opportunities as fixed income moves towards a new paradigm?



Latest insights




Short-dated corporate bonds: A natural next step for cash investors

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