Economic uncertainties continue to weigh on markets, but the good news is that bond valuations are now back to attractive levels, with yields offering a powerful source of return potential. Learn more from Group CIO Dan Ivascyn.
Amid Uncertainty, Value Returns to Bonds
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Text on screen: Ken Chambers, Product Strategist
Chambers: What are you and the investment committee discussing with this period of heightened volatility?
Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
Ivascyn: Sure, Ken. I think the most important point is that scenario analysis is critical. Not just focusing on base case views, but really focusing on more extreme scenarios, tails are fat today in terms of the distribution of possible outcomes and we're trying to have a healthy degree of humility for the fact that
When we look at the fixed income market opportunity set today, it's looking quite attractive both from an absolute perspective or versus cash for investors that may have been on the sidelines looking to avoid the volatility, or even coming from more risky positions within the equity markets where we are cautious on valuations and where we do think there could be a bit more downside within the equity universe specifically. So, with volatility, with a lot of trending markets in the wrong direction from an investor perspective comes opportunity and we're finally at a point where we do see considerable opportunities for the patient fixed income investor.
Chambers: On the back of that, can you talk about the attractive value proposition for bonds today?
Ivascyn: So when thinking about bond valuations, I think you have to think about a world with stickier higher sustained inflation on a go forward basis. So, I guess that's the bad news. Good news is a lot of this is priced into bond markets at the moment.
FULL PAGE GRAPHIC: TITLE – Valuations: Bond value returns. The bar chart shows Yield to Worst (%) for Core Bonds, Agency Mortgage Backed Securities (MBS), Investment Grade Credit, High Yield Credit, Emerging Markets, Munis, and High Yield Munis. As of September 30, 2022, the yields for all the bond sectors shown were significantly higher compared to their yields on December 31, 2021. The top three sectors with the highest yields as of Sept. 30 were High Yield Munis, High Yield Credit, and Emerging Markets.
So, the bottom line is that valuations have changed a lot very, very quickly. Financial condition tightening typically means better value for end investors within the debt markets, and it's finally arrived.
Today as a starting point looking forward is very, very different. When you're earning a 5% type annual yield, 6, 7, 8, 9%, that's a powerful source of return.
We're much more excited this quarter than the last several quarters where it felt like defense should be the focus, I think today careful investors could go on the offense and achieve pretty attractive value.
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