Capital Group has been moving overweight European bonds in its global investment grade strategies, Damir Bettini (pictured), portfolio manager at the American investment manager, told FSA during a recent interview.
Moving overweight European bonds at the expense of US fixed income has been a popular strategy with investment managers of late, particularly as the expected trajectory of interest rate cuts between the two regions has diverged.
Expectations of interest rate cuts have been pushed back in the US, due to several strong inflation prints, whereas the European Central Bank is still expected to push ahead with its first cut at its next June meeting due to the more benign inflationary backdrop.
Bettini is less preoccupied with the trajectory of interest rate cuts and emphasises more the difference in valuations between the two, noting also that there is a lot of dispersion in credit quality among European issuers as well.
“The growth trajectory in the US remains more positive, however a lot of that is already reflected in outright valuations measured in terms of spread levels. European investment grade (IG) is trading about 30bp back from US investment grade credit,” he said.
“There are obviously good reasons for that. It’s not a riskless premium. There is quite a large war happening in Europe for example. But those valuation differences at the index level also mark a dispersion in terms of the investment opportunities that exist.”
Meanwhile, Bettini also sees pockets of opportunities in Asia, particularly southeast Asia, notwithstanding the fact that the outlook for fixed income in the region has generally been clouded by economic woes in China.
“We’re looking at it entirely from the point of view of where are the valuations relative to the risks and we’re still finding lots of interesting investment opportunities throughout Asia, including Chinese companies,” he said.
“Asian valuations levels are between US and European levels. It’s that nuanced view, but we’re still finding lots of value throughout Asia including in China in terms of corporate bond investments that is reflected in our investment strategies.”
Investment grade outlook
Overall, Bettini is sanguine about the outlook for investment grade, notwithstanding the fact that it has had a relatively bumpy start to the year, due to volatility around interest rates.
Spreads have also been tightening. The ICE BofA US Corporate index option-adjusted spread was last quoted at 0.92% versus 4.01% at the height of the Covid-19 crisis, for example.
Bettini points to fact that all-in yields are attractive as well as the potential for rate cuts, which generally benefits investment grade over high yield because of the longer duration.
“Starting yields in IG at the moment are just under 6% on a dollar hedged basis. For an asset class at the index level that is A rated or A- rated, that’s potentially very appealing in terms of total return expectations,” he said.
“And if you start to think about potential future rate cuts, if you assume at some point over the next couple of years central banks are successful, for every 100bp that rates are cut and you assume a parallel shift in the curve, that’s an extra 6% incremental returns if you extend duration to six years.”
Regarding sectors, Bettini’s views are not too unorthodox insofar as he favours financials, specifically banks. He notes that there was a valuation premium following last year’s debacle with Credit Suisse and Silicon Valley Bank, although he adds that that premium has been compressing.
He notes that Capital Group’s investment grade strategies do invest in subordinated instruments, but because of the focus on quality, they do not invest in AT1 instruments.
Bettini also said that he has an overweight to utilities because of the transition towards clean energy, which has thrown up all sorts of pricing dislocations, while in the last few quarters it has also moved to a sizeable overweight position in pharmaceuticals, which he finds attractive both because of valuations and the trajectory of some of their business models, particularly around anti-obesity drugs.
