The debate over when to start rolling over fixed income has been going on for months. In fact, since late last year, when the market started pricing in up to six or seven rate cuts earlier this year. If that happened, it was the perfect time to anticipate those cuts and start investing in longer-duration bonds. The big risk that fixed income investors took back then was that this scenario would not come to pass, which is what eventually happened. Rate cuts were increasingly delayed, and it wasn’t until June that the European Central Bank made its first cut of 25 basis points. While further central bank action remains unclear, it is becoming increasingly clear that the pace of cuts could accelerate as early as 2025, prompting experts to extend the duration again.
“We have shifted our preference towards the longer end of the yield curve, where we believe the attractiveness is increasing,” research group Bankinter said in its strategy report for the third quarter of this year. “Term risk premiums have adjusted and at current rates we see value in the longer tranches.We recommend extending the duration to anticipate the impending rate cut in 2025.“they explain.
At this point, inflation in the United States is paving the way for the Federal Reserve to start cutting rates as well. Last month, the consumer price index (CPI) fell a tenth more than expected, to 3%, compared with 3.3% in May. Even the most watched data recently, the core CPI (excluding energy and food), also surprised by falling, falling a tenth more than expected, to 3.3% month-on-month, compared with expectations of 3.4%. A positive surprise that increases the likelihood that the Federal Reserve will begin cutting rates as summer approaches in September. After this data was released, the market began to discount that this would happen, whereas before the CPI data was released, the probability of a decline in September was only 70%.
“We still think that inflation will return to 2%, that there will be a rate cut. and yes, it’s time to increase the deadlines, not only now, but throughout this year“, agrees Antonio Aspas, partner and advisor at Buy & Hold, who adds that this period should be extended to approximately 4 years.
The ECB’s first rate cuts have already been partially felt in the debt market. Last week, there was a day when the 10-month paper offered a higher yield on the secondary market than the 12-month bill, which has not happened since November 2023 and which, in fact, makes sense. But the era of zero rates has caused anomalies in the fixed income market, including an inversion of the interest rate curve, due to which short-term debt (a priori less risky, since it is less sensitive to changes in interest rates) began to offer a higher yield than long-term debt. This situation needs to change now.
Alicia García, head of M&G Spain, noted in an interview with elEconomista.es a few days ago that “as we see further rate cuts from central banks, interest in debt funds with upcoming maturities will decrease and more entries will be seen in other countries with longer maturities. Over the last three weeks, we have already seen a clear appetite, although most of the market is considering investing in longer-term portfolios after the summer,” García emphasized.
The best tools to move forward
Rafael Ciruelos, partner and director of fund selection at Diaphanum, explains that conservative investors are advised to have a 2-2.5 year time frame for their entire portfolio and include some of the best-known funds due to their track record of profitability, such as B&H Debt or Carmignac Securité. “The former invests only in highly liquid investment-grade bonds with high credit quality and does not invest in bills, subordinated debt or high yields. yield 4.4% and duration 1.9 years.at the end of June. And it has very competitive fees. The second is a fund that invests in various types of fixed income, from developed country governments, corporate credit, CLOs, and even emerging market debt. It manages duration very actively. It currently has a yield of 4.8%, a duration of 2.4 years, and an average rating of A-,” says Ciruelos.
Another fund that Diaphanum also highlights is Tikehau Short Duration, which invests in low-duration investment-grade European credit. “The fund currently has a one-year duration, investment-grade credit quality, and a yield of 4.6%. It has a heavy weighting in financial sector securities, which provide the best returns to bondholders.. And they also have some investments in high-yield funds,” emphasizes Ciruelo, for whom “a combination of these funds could be a good option in the coming months, even if rates remain at these levels longer than expected.”
Miguel Irizarry, president and partner at Sássola Partners, adds MAN IG Global Opportunities, Abrdn Select Emerging Markets and EdR Bond Allocation to his basket of recommendations. As for the MAN GLG fund, he notes that it global fund, although it is now 83% invested in Europe, where the management team sees greater value. At best, you can have high-yield bonds with yields of 20%, although they are lower now. It has an IRR of 6.1% and a duration of 5.5. “The manager exploits profit opportunities in smaller issues and by using fundamental analysis similar to that of stocks. At the same time, adjusts the fund’s duration through U.S. futures to match the index“By doing this active management, he is reducing the spread duration and increasing the interest rate duration, which will benefit him when the expected rate cuts happen in the second half of the year,” Irizarry says.
The creation of a fixed income fund in emerging markets, according to the partner of Sássola Partners, is justified because these countries, despite having started the cycle of interest rate hikes earlier and having more controlled inflation, do not carry out significant rates of interest rate cuts to avoid the depreciation of their currency against the dollar due to high interest rates in the United States. But given the weaker economic data in the North American country,We expect rates to fall after the summer, and with that fall, emerging markets will begin to decline, so it will be interesting to assess the duration“.
Another fund that Sássola Partners recommends is EdR Bond Allocation, a flexible fund with a 6.8 duration and 5.4% internal rate of return that invests in both credit and government.The duration is secured by government bonds, mainly from Germany, with a maturity of more than 7 years.and represents a portfolio that is highly diversified across long-duration asset classes,” says Irizarry.
Ion Zulueta, director of research at iCapital, recommends another emerging debt fund, the GAM Emerging Local Currency Bond Fund. “There is value in emerging currencies, although their sustainable growth may require a continued risk environment and an end to dollar strength,” says Zulueta, who also bets on the Pictet USD Government Bond Fund, a vehicle with very low tracking error that provides diversified exposure to the U.S. yield curve.
In addition, he also suggests Nordea euro-covered bonds, as the credit spreads on this type of bond are priced at an attractive level compared to corporate credit, as well as the Pantheon Infrastructure fund, as “yields can be expected to approach the growth of NAV plus the discount at which the car is currently priced at 25%,” says Zulueta.
In ATL Capital’s case, its recommendations are MS Euro Corporate Bond, a euro fixed income fund that invests in high-credit-quality corporate bonds with maturities longer than four years and is broadly diversified across issuers and issues; and Invesco Euro Corporate Bond, a euro fixed income fund with about 400 bonds in its portfolio. “It complements MS because Invesco also invests about 10% in low-credit-quality bonds, which can provide it with additional returns.“its duration currently exceeds 5 years,” explains Miguel Perez, analyst at ATL Investment Solutions.
Some of the experts interviewed also highlight the classic optimal income of M&G (Lux), which currently has 41% exposure to sovereign debt, especially European.