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2021 was, by all accounts, a good year for convertible bonds (“convertibles”). Despite bouts of volatility along the way, both US and global convertibles posted positive total returns last year, comfortably outpacing many other fixed income market sectors — including sovereign government bonds, as well as high-yield and investment-grade corporates.

Looking forward, we believe convertibles may continue to prove resilient, potentially benefiting from their distinctive structure amid the anticipated inflationary and rising-rate environment of 2022. Here are those three predictions for the year ahead.

Prediction 1: Convertibles to outperform both investment-grade and high-yield bonds

Since 1998, convertibles have outperformed both the Bloomberg US Aggregate Bond Index and the Bloomberg US Corporate Index in every period when interest rates rose by…

MARKETS
Dunkelberger, Raina
Raina Dunkelberger
CFA
Investment Specialist
Boston
Barry, Michael
Michael Barry
Fixed Income Portfolio Manager
Boston

Barring unforeseen macro or market developments, we believe the bank loan asset class looks poised to deliver positive total returns in 2022. Here’s why:

Inflationary pressures have raised the risk of tighter monetary policy

As we move into 2022, inflation risks remain paramount from an investment standpoint. We expect many investors to grapple with the potentially adverse effects on their portfolios, particularly as ongoing repercussions from the COVID-19 pandemic continue to exacerbate labor shortages and supply chain disruptions worldwide. Broadly speaking, we think mounting inflationary pressures have ratcheted up the risk of tighter monetary policy on the part of the US Federal Reserve (Fed) and…

MARKETS
Jeffrey Heuer
Jeff Heuer
CFA
Fixed Income Portfolio Manager
Boston
Dave Marshak headshot
David Marshak
Fixed Income Portfolio Manager
Boston
Nick Leichtman
Nick Leichtman
CFA
Investment Specialist
Boston

The past several months have seen a flurry of activity in the official sector1 regarding US Treasuries, as policymakers and stakeholders attempt to explain the startling dislocations that hit the Treasury market — generally considered to be the world’s deepest, most liquid securities market — in March 2020.

Indeed, it was only through swift, aggressive intervention by the US Federal Reserve (Fed) that said market dislocations did not become even more pronounced. It marked the second time in just a few years that the central bank had to intervene in the Treasury market to restore and encourage orderly operations — the other time being the Fed’s purchase of T-bills in the fall of 2019, which was designed to stabilize the short-term interest-rate market.

Understanding what happened in March 2020

So what led to the Treasury market dislocations and illiquidity back in March 2020? At a high level, the prevailing narrative is that…

MACRO
MARKETS
Amar Reganti
Amar Reganti
Investment Director
Boston

In our early December quarterly strategy group meeting, we debated the outlook for the high-yield market in 2022 and what it means for portfolios. At present, we favor maintaining a slightly defensive risk positioning given tighter valuations. While the macroeconomic backdrop and corporate fundamentals generally remain positive, we see some points of concern emerging at the margin. We expect high-yield credit spreads to move sideways in a year that could see plenty of volatility given multiple tail risks. However, we believe the ability to dynamically adjust positioning in the event of a significant repricing of credit risk will be key in 2022.

Macro: positive, but less positive

We continue to observe “yellow flags” on inflation and are watching for signs that inflationary pressures could shift from transient to permanent, leading to faster-than-expected tightening. On the flipside, previous Federal Reserve (Fed) policy cycles suggest that the high-yield market tends to perform well during the early stages of hiking when rate increases are…

MARKETS
Barry, Michael
Michael Barry
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

As discussed in my recently published 2022 Fixed Income Outlook, co-authored by my colleague Jitu Naidu, we believe inflation and interest-rate risks look poised to supplant the global COVID-19 pandemic as the new “bogeymen” facing investors in 2022. The dual specter of persistently higher inflation and steadily rising rates has many allocators particularly worried about potential implications for their fixed income exposures. Accordingly, many are now seeking defensive portfolio strategies — so-called “hedges” — for the new year.

Possible inflation scenarios

Market pricing for longer-term US inflation was recently in the mid-2% range, based on the latest “breakeven” inflation rates. There are still ongoing debates as to likely inflation outcomes going forward, but most of the informed forecasts appear to…

MACRO
MARKETS
THEMES
Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

The fixed income market dislocations triggered by the onset of the COVID-19 pandemic left active portfolio managers with extraordinary opportunities to generate alpha not seen since the 2008 global financial crisis. Accordingly, many are well ahead of their benchmarks since COVID: The percentage of active core bond-plus and global aggregate bond strategies besting their benchmarks has spiked sharply to over 80% and 90%, respectively.1 Many fixed income allocators have, of course, benefited mightily from this recent spurt of active manager outperformance.

On the surface, there doesn’t seem to be a problem here, right? However, a closer look at this “golden era” of excess returns reveals potential structural manager biases and stylistic tilts that most investors may not expect, or necessarily want, from their fixed income allocation. These risk factor leanings have enabled many active managers to…

MARKETS
Brendan Fludder
Brendan Fludder
CFA
Research Manager
Boston
Carlos Coutinho
Carlos Coutinho
CFA
Solutions Portfolio Manager
Boston
Noah Comen
Noah Comen
CFA
Investment Strategy Analyst
Boston

The US Federal Reserve’s (Fed’s) message on inflation has changed. Fed Chair Jerome Powell recently characterized supply shocks, bottlenecks, and disruptions as “frustrating” and as “holding up inflation longer than we had thought.” The Fed’s mea culpa is small consolation for investors whose portfolios have not been positioned optimally for a longer-than-expected period of higher inflation.

The question now is: Has inflation already peaked? The short answer is no, in my opinion.

The systemic nature of supply shocks

Inflation is being pushed higher by three catalysts — labor, raw materials, and transportation — that are interrelated in ways that…

MACRO
THEMES
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

For many fixed income investors, we believe high-quality securitized assets can play a valuable role in a diversified credit portfolio — and they have become even more attractive thanks to new risk-based capital (RBC) factors being adopted by the National Association of Insurance Commissioners (NAIC).

Should non-insurance entities care about these changes? We think so because the changes could impact credit spreads and investor demand across the securitized sector. For instance, we may see greater demand for AAAs/AA rated bonds and less demand for As, which could affect…

MARKETS
Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston
Tim Antonelli
Tim Antonelli
CFA, FRM, SCR
Multi-Asset Strategist
Boston
Klimas Celene
Celene Klimas
CFA
Investment Specialist
Boston

With a sustained rise in interest rates in the coming months a distinct possibility as of this writing, we thought now would be an opportune time to take a close look at some potential impacts of higher rates on clients’ fixed income portfolios. To do so, we compared the hypothetical five-year performance of the Bloomberg US Aggregate Bond Index under three different illustrative scenarios that could play out going forward: 1) rates remain unchanged; 2) rates rise abruptly; and 3) rates rise gradually (i.e., over three years).

Key takeaways for fixed income investors

A few of our main takeaways from this analysis were as follows:

  • While abrupt rises in rates might lead to short-term drawdowns in fixed income portfolios, they can at times be desirable for longer-term investors, given opportunities to…
MACRO
MARKETS
Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

The challenges of the past 18 months or so have highlighted the potential for environmental, social, and governance (ESG) factors to become even more relevant to asset management and have underscored the ever-increasing importance of stewardship by fiduciaries and active investors alike. ESG has quickly become one of the defining investment criteria of this decade — a trend we have little doubt will endure in 2022 and beyond.

We have long believed that mounting sovereign debt burdens pose a risk to investors, even in developed markets. At the very least, investors are not being adequately compensated for investing in the most heavily indebted countries. Given the sharp rise in government debt levels in response to the global COVID-19 crisis, it’s an opportune time for sovereign bond investors to refresh their investment frameworks, the particular metrics to be applied, and their country selection methodologies, including the ESG factors underlying investment…

MARKETS
SUSTAINABILITY
Marion Pelata
Marion Pelata
Fixed Income Portfolio Manager
London
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Congress has effectively “kicked the can down the road” by raising the statutory debt limit sufficiently to meet Treasury obligations until December 3. This is by no means a solution to the problem, but rather just delays the inevitable uncertainty related to the debt “ceiling” drama that is likely to build as December approaches.

US Treasury bills (T-bills) are continuing to react to the ongoing uncertainty. Notably, we have observed a noticeable “cheapening” of T-bills scheduled to mature in December, creating a “hump” in the T-bill yield curve that moderates in late December and into January (Figure 1). In our view, this turn of events does not present an opportunity for bond investors to reach for incremental yield, as we believe they should instead be focused on preserving liquidity through their T-bill allocation.

Treasury market jitters

In anticipation of the possibility of a technical debt default by the US government, T-bills with maturities falling shortly after the new December 3 deadline to raise the debt limit are commanding a…

MARKETS

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Balaji Venkataraman
Balaji Venkataraman
Investment Specialist
Smith Timothy
Tim Smith
Fixed Income Portfolio Manager

Last week, a blog post titled Fixed income investors warily eye Congress and the Fed discussed three likely government policy drivers of fixed income markets in the period ahead — US monetary policy, US fiscal policy, and the US debt ceiling. Here, we’ll take the next step of briefly highlighting some fixed income market sectors where investors might turn for attractive total return opportunities in today’s challenging environment. Indeed, it’s perhaps the most pressing question many fixed income clients have been asking lately.

A supportive US policy backdrop

The prevailing US monetary and fiscal policy backdrop continues to be broadly supportive of credit fundamentals, but many credit sectors are not currently…

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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston
Amar Reganti
Amar Reganti
Investment Director
Boston

From rising inflation to the COVID Delta variant and more, there is no shortage of risks and challenges facing investors in today’s global market landscape. But from our perspective, many fixed income market participants have been more or less “looking past” such macro concerns in favor of a more upbeat narrative around continued economic recovery and growth. This narrative has gained ample support from the global trend of ongoing monetary and fiscal policy stimulus, particularly in the US, since the onset of COVID. What happens in Washington doesn’t stay in Washington.

With that in mind, let’s examine the key US government policy catalysts that have been moving fixed income markets in recent months and may continue to do so in the…

MACRO

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Amar Reganti
Amar Reganti
Investment Director
Boston
Jitu Naidu
Investment Communications Manager
Boston

Sustainable investing is no longer the exclusive domain of equity investors. Indeed, there is a growing consensus that sustainability can be just as critical to investment outcomes in fixed income markets. Although environmental, social, and governance (ESG) integration and adoption have historically been slower in fixed income as compared to equities, investor demand for “green bonds” and other sustainable fixed income solutions has risen rapidly in recent years, particularly since the onset of COVID-19. Accordingly, the pace of new product innovation and proliferation has picked up as well.

Case in point: The booming global market for green/sustainability bonds has now expanded to convertibles — hybrid bonds that can be converted from debt into equity. While European debt issuers have thus far comprised most of the volume in these green, sustainability-linked, and/or social bonds, US and Asian issuers have become increasingly active in the space. The recent uptick of issuers selling green/sustainability convertible bonds includes companies focused on…

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SUSTAINABILITY

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Dunkelberger, Raina
Raina Dunkelberger
CFA
Investment Specialist
Boston
Barry, Michael
Michael Barry
Fixed Income Portfolio Manager
Boston

As credit spreads have compressed to post-global financial crisis tights, and with bond yields hovering near all-time lows, I believe the total and excess return prospects for investment-grade fixed income look rather grim. Tight valuations, coupled with some looming risks on the horizon (the COVID Delta variant, inflationary pressures, fading fiscal stimulus, and China’s slowdown), may present an opportunity to “take some chips off the table,” so to speak. I recommend reducing both credit and interest-rate risk in many investor portfolios.

The technical backdrop remains strong

Investment-grade credit has been well-supported by strong demand from non-US investors and the domestic pension community. For overseas investors, US credit is still their best option on the yield “menu” (made even more attractive on a currency-hedged basis), given lower prevailing yields across most other developed markets. Many defined benefit pension plans have been…

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Connor Fitzgerald
Connor Fitzgerald
Fixed Income Portfolio Manager
Boston

Figure 1 highlights the six-month trailing correlation between the S&P 500 Index and the 10-year US Treasury bond as of 20 July 2021. This stock-bond correlation has shot up over the past six months or so from near all-time lows to its highest levels since before the 2008 global financial crisis. What does it mean?

Figure 1

Six-month stock-bond correlation

First, one caveat: The equity-bond correlation can be volatile, particularly amid fears of monetary policy tightening — for instance, a sharp spike around the…

MACRO
MARKETS

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Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston

It’s been a volatile ride for the US fixed income market through the first half of 2021. After interest rates seemed to be more or less “renormalizing” in their climb back to pre-pandemic levels, the US Treasury market rallied: In the span of three months, the yield on the 10-year note dropped from 1.74% on March 31 to 1.45% on June 30.

To many market participants, this downward move may seem counterintuitive. US economic activity has continued to pick up with the widespread, successful rollouts of the COVID-19 vaccinations. Accommodative monetary policy along with generous fiscal policy should be a strong tailwind to economic growth into the second half of 2021 and beyond. And inflationary pressures have clearly increased over the past few months.

In theory, all of this should translate into higher interest rates, but that hasn’t…

MACRO
MARKETS

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Amar Reganti
Amar Reganti
Investment Director
Boston

In our last blog post in March, we recommended a slightly defensive risk posture for high-yield investors, with a focus on individual security selection. In our view, today’s high-yield bond market requires a carefully balanced approach. We remain selective with a modestly defensive risk tilt given rich valuations, while recognizing that low spreads may last longer thanks to ongoing monetary and fiscal support. We will watch for signs of central banks tightening or deteriorating liquidity before turning more defensive.

Macro environment: Positive

  • At the time of writing, short-term economic data and corporate earnings are as good as it gets, thanks to the stimulus. We expect a modest slowdown into the second half of 2021.
  • Inflationary pressures are building across both emerging markets (EM) and developed markets (DM), with price rises potentially spilling over from goods into services. Policymakers view these pressures as a transitory phenomenon, but we will monitor to determine whether they prove more enduring.
  • We are concerned about these dynamics and…
MARKETS

ARCHIVED

Christopher Jones
Christopher Jones
CFA
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

For fixed income investors, varying the amount of credit risk in your portfolio can exert a major influence on the portfolio’s realized alpha. Indeed, historical data shows that this single factor can have a larger impact than decisions around what bond sectors or individual issuers to invest in. Accordingly, it’s worth spending some time thinking about precisely how much credit risk to take and when. My latest research in this area focuses on the role that valuation can play in adjusting credit risk over an economic cycle.

Methodology at a glance

I looked at the strategic timing of buying and selling credit exposure (in the form of corporate bonds, using cash or US Treasuries as a funding source) with low turnover, and using market valuation as the sole buy/sell signal. There are, of course, other predictive drivers of credit returns, such as…

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Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

The US Federal Reserve’s (Fed’s) message on inflation is clear: Higher domestic inflation is likely in the period ahead, but it should be “temporary” in nature. This begs several questions, among them: What exactly does “temporary” mean? Which price increases, if any, could be longer lasting? And if higher inflation proves to be “stickier” than anticipated, how should investors position their portfolios?

The Fed’s latest forecast is for the Consumer Price Index (CPI) to rise to 2.6% this year (which it already hit in March), before settling back down to just over 2% in 2022 and 2023. Likewise, market expectations (as observed in recent “breakeven” inflation rates) are for US inflation to pick up in the near term and then come down longer term. Yet I am hearing from some of my analyst colleagues that many areas of the economy are facing stubborn supply shortages and upward price pressures, including freight, semiconductors, housing, raw materials, and labor.

Thus, in my view, the risk is that higher inflation may have a longer-than-expected “tail” before…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
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