Turbulence ahead for fixed income
Bond markets may face a period of short-term uncertainty but could prove critical to the implementation of wider environmental, social and governance (ESG) initiatives across the globe, according to Newton Investment head of fixed income Paul Brain and analyst and portfolio manager Scott Freedman.
Global bond markets have faced some bumpy conditions in 2021 and could be set for more volatility in months ahead. Against an unusual market backdrop of rising inflation and falling yields, Newton head of fixed income Paul Brain sees potential for turbulence ahead.
“This year has been a difficult one and we expect it to continue to be quite a tough period for fixed income markets, though we believe the longer-term outlook looks more positive for bonds and that there is still some value to be found across fixed income markets.”
Commenting on previous periods of bond market volatility, Brain adds: “Historically, bear markets in fixed income don’t tend to last that long though they can be painful and I do believe we will see inflation running at above the 2% level for a while.”
“That said, we also believe there are pockets of value to be found in areas such as high yield and bond investors can always take a global approach to access markets. In some cases, central bank behaviour may vary in its impact on fixed income assets across individual geographic markets, creating specific areas of opportunity.”
He adds that fixed income investment can also bring some investment benefits at times of wider market stress, thanks to its negative correlation with risk assets. More broadly, he sees huge potential for bond markets to support responsible investment initiatives and global moves to address ESG factors.
“Fixed income issuance and investment is enabling the transition away from carbon intensive economic models by providing capital to companies and to governments which are going to drive that economic and environmental change going forward. We believe bond markets could become one of the biggest sources of capital for responsible investment.”
Newton analyst and portfolio manager Scott Freedman adds that while fixed income markets have tended to lag equity markets in terms of the implementation of responsible investment strategies, they are catching up fast. In the process, he believes they are also helping to repair the damaged reputation of a sector badly hit by the global financial crisis.
Freedman agrees that both central banks and fixed income investors can play an increasingly pivotal role in directing capital to projects that can help transition the planet to a potentially more equitable, lower carbon global economy.
“While the global financial crisis tarnished the reputation of many financial institutions, the need to transition our economy allows participants such as central bank and the fixed income market to become a potential force for good in society,” he says.
“There are already some huge central bank stimulus programmes in place. But that is just a start. In future these institutions will feed capital through to private markets, with capital markets themselves playing a greater role in servicing society in positive ways.”
Freedman adds that shifting regulation is playing a key role in encouraging wider adoption of responsible investment approaches and strategies across many developed markets.
“Shifting regulation means we have already seen the ‘greening’ of some quantitative easing (QE) programmes. This could, over time, filter through to private markets. In the US for example, if investors are more specifically able to consider ESG factors in terms of their fiduciary duty to clients, I think we are going to see a significant growth, not only in issuance of green labelled bonds but also demand for products in this area,” he says.
Within wider bond markets, Freedman says issuers are increasingly aligning their strategies more closely with sustainability objectives and taking more care to ensure they address ESG factors properly. While some investors commonly assume only equity holders can exert real influence over the companies they invest in, Freedman is quick to stress fixed income investors can and do also make a real difference in influencing corporate behaviour.
“While bond holders cannot vote shares, they do have the option to deny companies capital. Conversations around this can have a real influence and lead to more industry collaboration and positive change in some areas,” he adds.
For all this, Freedman does believe fixed income markets are not entirely free of so-called greenwashing – where companies exaggerate their green credentials or provide misleading evidence about their commitment to addressing ESG Factors – though he believes thorough due diligence and careful ongoing analysis could help investors avoid greenwashing pitfalls.
“There does appear to be evidence of some greenwashing in fixed income markets, but fundamental analysis can usually get to the bottom of that. At a more basic level, investors always need to consider whether the responsibility and sustainability milestones and targets companies set themselves are robust enough and are realistic. While responsible investment and ESG strategies are a positive thing it’s is also worth remembering that even green bonds can go bust and some companies can and do default,” he concludes.
748643 Exp: 29 April 2022