Julien Eberhardt and Lewis Aubrey-Johnson share their thoughts on some of the key themes in bond markets right now, and how these are influencing the management of the Invesco Euro Corporate Bond Fund.
The rise in inflation as the global economy emerged from the pandemic has had a huge impact on the bond market. Most of the shift higher in yields happened in 2022, but this year has also been challenging, with further rate hikes and high volatility. We think the environment now is positive for bonds and we are happy that we are being paid a good yield for the risks.
Duration has been the main driver in this period. The yield of the bund index rose from -0.5% in December 2021 to +2.5% at the end of 2022. This meant a negative return of nearly 18% for holders, but it also created a much better entry point. We increased our duration over the course of 2022 as yields rose, and we have increased it more since.
This more bullish positioning is not just based on higher yields. We think that the macroeconomic environment supports interest rate-sensitive assets.
Rate hikes have consequences – and we are now starting to see these in the economic data. Inflation remains high but it is falling. Credit conditions and economic sentiment are weaker. Furthermore, the labour market is cooling. All these factors suggest that we are moving to the peak of the interest rate cycle.
At this point in the cycle, we should be more comfortable with rate risk – and we are. These factors also suggest that investors should be more wary of credit risk, as weaker conditions bite on earnings at the same time as higher borrowing costs are hitting the bottom line.
Since the start of 2022, we have moved from holding 25% less duration than the euro investment grade market to holding 15% more. Although longer-dated bond yields are lower than shorter-dated, we have been happy to hold these to lock in yields and potentially profit more from falling interest rate expectations.
We have also increased the quality of the portfolio, adding to core investment grade holdings and cutting exposure to higher credit risk names.
The scenario of the tighter monetary environment pushing down inflation and rate expectations has been challenged in the last few months. Economic data has been stronger than expected, particularly in the US. Furthermore, oil prices have moved higher. This has pushed bond yields to price in a slightly different outlook – one where higher inflation prompts central banks to keep rates high for longer, and higher growth gives them the opportunity to do so. As a result, longer-dated bond yields have risen more, which has hit the returns for a portfolio like ours.
Despite this, we remain happy with our positioning. These recent moves have been a reminder that it takes time for interest rate changes to have their effect.
The US economy has indeed been resilient. And there are a few key reasons for this. The savings built up in 2020 have cushioned consumption and the labour market has remained strong. While rates for new mortgages are high, the effective rate on the total book of mortgages is only just starting to rise.
But those excess savings have been shrinking since 2021 and job growth is slowing. Not only are mortgage rates now climbing, but there are early signs of stress in rising bankruptcies and auto and credit card debt delinquency levels. All of this will put pressure on consumer sentiment which, in turn, should push down inflation, helping the central banks to meet their objectives.
We remain convinced that this is a good time to hold fixed income.
In our opinion, we are close to the top of the rate cycle and we are being paid a good yield on our bonds. If rate expectations fall, the duration of our portfolio means we will gain from price appreciation. But if rates stay high, we will still get the yield.
As the yield curve chart shows, the big move in the last three months has been the rise in long-dated yields relative to short-dated, but the real story remains the much larger rise in yields overall since 2021.
Source: Invesco as of 30 September 2023.
The Invesco Euro Corporate Bond Fund invests in a diversified portfolio of investment grade bonds, denominated in Euros. Without benchmark or duration constraints, the managers are free to adapt to market conditions as they evolve.*
*This investment concerns the acquisition of units in an actively managed fund, and not in a given underlying asset.
For complete information on risks, please refer to the legal documents.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Debt instruments are exposed to credit risk which is the ability of the borrower to repay the interest and capital on the redemption date.
Changes in interest rates will result in fluctuations in the value of the fund.
The fund uses derivatives (complex instruments) for investment purposes, which may result in the fund being significantly leveraged and may result in large fluctuations in the value of the fund.
The fund may invest in distressed securities which carry a significant risk of capital loss.
The fund may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.
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All data is provided as at 23 October 2023, sourced from Invesco unless otherwise stated.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
Views and opinions are based on current market conditions and are subject to change.
Not all share classes of this fund may be available for public sale in all jurisdictions and not all share classes are the same nor do they necessarily suit every investor
For information on our funds and the relevant risks, refer to the Key Information Documents/Key Investor Information Documents (local languages) and Prospectus (English, French, German, Spanish, Italian), and the financial reports, available from www.invesco.eu. A summary of investor rights is available in English from www.invescomanagementcompany.lu. The management company may terminate marketing arrangements.
Invesco Asset Management (Schweiz) AG acts as representative for the funds distributed in Switzerland. Paying agent in Switzerland: BNP PARIBAS, Paris, Zurich Branch, Selnaustrasse 16 8002 Zürich. The Prospectus, Key Information Document, and financial reports may be obtained free of charge from the Representative. The funds are domiciled in Luxembourg
