Barings sees stronger case for fixed income

Fixed income continues to offer investors the potential for attractive returns despite looming recession, persistent inflation and tighter credit conditions.

Despite these macro factors stoking fears of widening credit spreads and an imminent wave of defaults, Barings says investors should look beyond this prevailing negativity and general market unease.

“In managing fixed income portfolios through the ups and downs of many past economic cycles, our team has found that markets generally overreact both to the upside and downside,” said Martin Horne, global head of public assets at Barings.

“For savvy investors, intent on finding both absolute and relative value through deep credit analysis, environments like the one we face today can therefore offer some of the best long-term opportunities for total returns,” he added.

Prepared for a prolonged downturn
The first reason for Horne’s view is the fact that today’s economic downturn has been one of the most widely anticipated in recent history. As a result, companies have had more time than they would usually expect to prepare, enabling management to manage costs and inventory levels.

“Many companies have also reduced leverage levels and proactively increased the maturity profile of their debt,” he added.

While a recession will undoubtedly trigger some decline in credit quality, any earnings falls that follow slowing growth are therefore likely to be orderly, making default rates lower than in previous downturns.

“Indeed, high yield issuers are in a stronger financial position to ride out a challenging period than they were pre-pandemic, while the credit quality of the global high yield bond market has also improved considerably since the global financial crisis,” said Horne.

Finding new opportunities from dislocation
Another driver of a more optimistic fixed income outlook is the somewhat counterintuitive view that a tighter credit environment could be favourable for investors in both public and private credit markets.

This stems from Horne’s belief that concerns among public fixed income investors that banks might now have a lower propensity to lend, in turn triggering liquidity problems for borrowers in public markets, may be overblown.

“Opportunities to finance healthy companies that would otherwise have tapped banks are likely to increase,” he explained. “And with the supply/demand dynamics moving in favour of lenders, investors can expect to earn not only attractive yields but to do so with added structural protections.”

Horne noted that providing capital when capital is scarce can be an attractive source of returns for investors willing to take smart credit risk, even in a downturn.

Yields offering a good buffer
Yield levels across most fixed income assets offer a further benefit for investors – they are at levels not seen since the global financial crisis.

“Trying to precisely time the right entry and exit points is extremely difficult, but fixed income offers the potential for higher and more dependable absolute returns than many other asset classes,” said Horne.