This year, an exceptional environment provided us with an unusual recession and most of us will surely be happy to see the end of 2020. The instant outbreak of a global pandemic resulted in lockdowns to limit the spread of COVID-19, contraction in the global economy and a continuation of monetary and fiscal stimulus, which in return helped support the global economy to remain afloat. Low inflation and lower interest rates, together with prompt central banks’ actions, have contributed for strong returns in fixed income investments since the last week of March.
Although lately we have experienced a rise in COVID-19 cases, with the probability of having the vaccine approved to be widely distributed within weeks, and with the possibility of more fiscal aid, we are hopeful that 2021 will gradually bring back some normality in the economy.
Julien Houdain, deputy head of Credit – Europe at Schroders, said: “The fragility of the recovery at present means central banks need to maintain policy support, which should be helpful to corporate bonds. One of the biggest foreseeable risks is that policy measures are reduced or withdrawn too soon.”
For the income investor, the current savings accounts, money market funds or government bond yields are insignificant or, even worse, are generating negative yields in some parts of the word. We expect central banks and governments to retain the policy stimulus, especially the credit facility to purchase investment grade and high-yield corporate bonds, which should lead to tighten the spreads next year.
Although yields on certain corporate markets like Europe are low, the US market offers higher yields. Thus, corporate bonds are expected to remain more popular than government bonds when also taking into consideration inflation. In fact, many expect the 10-year Treasury bond yield to trade in the range of 1.0 to 1.6 per cent in 2021 on the basis that we experience a fast economic growth, while the short-term interest rate is expected to remain close to zero throughout the year as the Fed awaits inflation to start rising.
Emerging markets stand to benefit from the US trade policy under the Biden administration
For clients who are looking for further diversification and who can tolerate a certain level of portfolio volatility in return for higher potential returns, emerging market corporate bonds in USD offer an acceptable yield, especially after taking into consideration the current global low interest rate scenario and the various restructuring debts which took place this year in high-yield bonds. On the other hand, emerging markets stand to benefit from the US trade policy under the Biden administration.
With the prospect of distributing the COVID-19 vaccine globally by the first quarter of 2021, we should see a more stable environment with high-yield bonds delivering an average annual return of around four per cent. However, cautious investors might still prefer to opt for safer alternatives with a lower yield by investing in investment grade bonds.
Although the market has reacted positively since the drop in March, there is still room for improvement in sectors which still needs to recover, such as the consumer discretionary sector and energy.
Several sectors have been affected more than others, with various companies registering record levels of corporate debt to survive through the crises. Through the help of policymakers, this concern has been mostly tackled and the level of debt has been stabilised or even reduced. Thus, it is imperative to be selective on which securities to choose, including the sector in which they operate to balance the return vis-à-vis the risk involved.
Finally, sustainability has taken a central role for economies and corporations. With climate change, investors need to prepare themselves for a faster transition to net zero emissions across economies. Sustainability has become an important component of how we think about investing and will become an integral component of fixed income strategies. In general, 2021 seems to be a challenging year for fixed income investors. Areas affected by the pandemic are showing signs of recovery with high-yield and emerging markets offering more value.
The importance of diversification across sub-asset classes within fixed income and being selective between country and sector exposures, are important factors for a fixed income portfolio to successfully find a balance between risk and positive income returns.
This article was prepared by Matthew Magro, investment adviser at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For more information, contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on 2122 4410, or e-mail email@example.com.
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