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Capital Group outlook: Fixed income to shine in 2023

Fixed income, Capital Group outlookFixed income looks poised for a return in 2023 as 60% of UK financial intermediaries anticipate heightened confidence, expecting to increase allocation in the asset class over the next 12 months, investment firm Capital Group reported in its fixed income outlook session for 2023.

According to financial intermediaries surveyed, the role fixed income plays in a portfolio is predominantly as a tool for diversification (83%), followed by capital preservation (53%), income generation (51%) and inflation protection (23%).

Chris Miles, head of UK financial intermediaries, Capital Group, said: “Against a backdrop of ongoing market uncertainty, our research reveals that the key challenge intermediaries and their clients is increased asset volatility (58%). A global high-income solution that seeks to capture diversified income streams can bring a more resilient income profile to client portfolios while complementing domestic investments.”

New year, new focus

Flavio Carpenzano, investment director, Capital Group, batted for bonds to bounce back this year. “2022 was one of the worst years for fixed income due to higher interest rates driven mainly by three main headwinds – a massive increase in yields resulting from central bank activities, unusual speed of repricing and entry into the volatility phase amidst low yield levels.”

2023 is unlikely to witness the same magnitude of sell-off, Carpenzano remarked.

“Volatility in 2022 was mainly driven by high inflation followed by central banks' rate hiking. The risk focus for 2023 is likely to be on recession. In the scenario that the correlation between equities and bonds renormalises, core government bonds would offer diversification when equities suffer,” added Carpenzano.

Capital Group's research revealed that average five-year forward returns (p.a.) at the current starting yield touch double-digits – particularly for emerging market hard currencies. The figures are similar to the equity market, and come with lower volatility, highlighted Carpenzano, affirming that starting yield is a driver of returns over the long term.

“The high yields market is entering a period of a potential recession, but this time, with a position of strength stemming from three main components. These include enhanced credit quality of US high yield market, domination of BB bonds ( roughly 65%) in the US energy sector, and low refinancing requirements for high yield companies this year,” Carpenzano said. "Income is back as the key driver of returns for bonds, especially over the long term, delivering more predictably."

Emerging markets to stay

Kirstie Spence, fixed income portfolio manager, Capital Group, said: “There are opportunities in both high yield and emerging markets as they remain among the fixed income investment opportunities providing positive real yields in an inflationary environment. A portfolio combining both asset classes helps provide investors with a more diversified yield and income to offset further volatility.”

Emerging market debts (EMD), “a mainstream asset class”, are often misjudged, Spence pointed out.

“Earlier, EMDs were less about income and more of a credit story, mostly dominated by Latin American and central European markets. Now there are more emerging countries with evolved local and hard currencies as well as deep, liquid and mature yield curves indicative of their financial and economic progress," said Spence.

The EMD universe has expanded with various corporate, government and local bonds on offer. "If the inflation or policy dynamics are unfavourable, we, as asset managers, could opt for short durations just as in a developed market portfolio," said Spence. "To sum up, EMD is here to stay and not to be viewed as temporary or tactical."

Against an inflationary backdrop, EMS are ahead of the policy curve than developed markets with the potential for higher yields while leverage remains low, highlighted the Capital Group survey. "Yields have risen, fundamentals are stable, and EMs have managed inflation more proactively than developed markets. This paves the way for a safer entry point," said Spence. "Foreign exchange valuations are also at their cheapest values in the past decade, offering better inflation-linked opportunities.”

The firm also launched an OEIC fixed income fund for UK investors - the Capital Group UK - Global High Income Opportunities fund on January 18. The fund combines high-yielding fixed income sectors – primarily developed market high-yield bonds and EMD – with similar risk-return profiles but different market cycles to offer diversification benefits, income opportunities and the potential for less volatile returns.

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