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Bonds are back, and so is risk

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This is a sponsored article from Neuberger Berman.

Tobias Bracey, Neuberger Berman

The search for yield is over, but the risk-management challenge has just begun.

A shift into higher rates globally over the latter part of 2023 has created a new investment regime in fixed-income markets, prompting investors to re-evaluate their asset allocation. Previously, the common view on positioning within the asset class was either to extend duration or lower the quality of portfolios to generate higher yields. Now, given the changes in the market, this is no longer the case.

Yield curves remain inverted, meaning investors can achieve attractive returns without having to unduly extend duration. Looking at the high-quality part of the market, even short-term US government bonds now offer yields of 5% or higher, while agency mortgages can provide yields of 5.5% or more. In the case of non-investment grade credit and emerging markets, yields in the high single digits are possible.

We believe today’s higher yields are here to stay, making bonds a critical source of portfolio income and total return after a decade in the doldrums. However, higher yields reflect elevated inflation and credit risks. This underscores the critical role of portfolio managers and flexible strategies designed to diversify risk and focus on credit quality.

Higher for longer?

With roughly 500 basis points of rate hikes in the rearview mirror, the Federal Reserve has made significant progress in curbing US inflation. However, reducing core inflation remains a challenge, and many developed market central banks have recently taken a more hawkish tone.

Mopping up the last bits of excess inflation often takes longer than clearing the more transitory drivers. Long-term, structural forces – such as changing demographics, deglobalisation and decarbonisation – are likely to make inflation stickier than we have become used to over the past two decades.

We believe interest rates are at or near their peaks in the US and Europe, but equally, we do not expect them to be cut soon. We expect the Fed to maintain a real policy rate of 1-2%, and US core inflation will end between 3.5% and 4.0% this year.

As we get closer to the end of the hiking cycle, this presents a window of opportunity for bond investors to lock in attractive yields before we move into the next phase of rate cuts. Moreover, there is potential for not only high income in the markets but equally positive total returns over the forward-looking environment.

We have identified three potential market scenarios and accompanying portfolio positions to consider for the next 12 months. Flexibility, experience, and depth and breadth of market knowledge, are critical to navigating all three. Each scenario presents its own nuances and challenges.

A flexible multi-sector bond strategy that can navigate all three scenarios

Multi-sector strategies which adopt a flexible approach to fixed income allocations can play an important role in this environment. Access to the broadest possible range of markets and the ability to make robust relative value comparisons between them can be advantageous when diversifying exposures and finding the optimal trade-off between yield and risk.

Having the flexibility to respond nimbly to evolving economic data and investor sentiment can make navigating through a volatile environment easier. A simple way for investors looking to increase or switch up their fixed income allocations and to access all these benefits is through the Neuberger Berman Strategic Income strategy, the fund manager’s flagship, multi-sector offering.

This foundational multi-sector fixed-income strategy aims to deliver attractive total returns and a consistent income stream. With a dynamic duration of two to eight years, the strategy is designed to adapt to a shifting market environment, given its flexibility to invest in different buckets. Through a diversified relative-value approach, fund managers can effectively capitalise on market opportunities and mispricings as they come and go.

The experienced investment team leverages the depth of insights from across the Neuberger Berman fixed-income platform, with a long-term track record of positive returns in 16 out of 19 years, including challenging ones such as the Global Financial Crisis, the Euro crisis, and the Covid pandemic.

In the above range of possible macro outcomes, our baseline expectation is that this year is about making progress on disinflation, but at the same time, inflation is likely to remain above central bank targets for some time beyond 2023. Therefore, despite a potential consumer-led growth slowdown, we see limited scope for rate cuts, presenting a challenging balancing act for central banks.

In this environment, we believe that a risk-conscious investment process is critical as fundamental risk in credit portfolios is expected to rise and increasingly drive outcomes. This makes security selection expertise as important as ever.

For Sophisticated Investors in Hong Kong and Singapore Only

Tobias Bracey is a Client Portfolio Manager in the Fixed Income team of Neuberger Berman. Based in Singapore, he is responsible for representing the firm’s fixed income strategies across APAC including Australia.

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This is a sponsored article from Neuberger Berman.

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