This article is part of the latest Trends and Opportunities report, which seeks to provide therapy for recent market shocks by offering long-term perspective and potential solutions.

Flexible multi-sector bond strategies may help investors “average in” to higher yielding opportunities, while at the same time allowing them to remain nimble

YTD Recap

• There has been significant divergence among sectors within the diversifying fixed income universe this year.
• Emerging Markets has dealt not only with the impacts of quantitative tightening (QT) but also with more direct ramifications from the Russia/Ukraine conflict. Floating-rate bank loans have held up better due to their rate-resetting component as the Federal Reserve (Fed) has hiked 225 basis points in 2022 so far.
• As the narrative has shifted from inflation to slowing growth, credit spreads – particularly in the below investment-grade universe – have begun to widen.

An Uneven Selloff

Source: Morningstar as of 8/31/22. S&P/LSTA US Leveraged Loan TR, Bloomberg US Treasury US TIPS TR USD, Bloomberg US MBS TR USD, Bloomberg US Treasury TR USD, ICE BofA Fxd Rate Pref TR USD, Bloomberg US High Yield Corporate TR USD, Bloomberg US Corp Bond TR USD, ICE BofA US Convt Bonds TR USD, JPM E

Outlook

• Wider spreads and higher rates now provide greater total return potential for investors willing to take on more risk in fixed income. However, the recovery will likely be marked by dispersion across and within credit asset classes.
• Floating-rate bank loans may lose some luster as the hiking cycle slows and credit quality becomes more important, while emerging markets continue to grapple with a strong U.S. dollar, pandemic uncertainty, and geopolitical risk.
• High yield spreads have approached levels generally seen as attractive but still remain far from what is typically seen in a recession.

Single Sector Spreads have Room to Widen

Source: Bloomberg as of 8/31/22. *Avg Peak spread levels exclude ’08 and ‘20 selloffs

PCS Perspective

• This year’s sell-off presents some extremely attractive discounts (and even dislocations) in many high-risk and high-yield asset classes, offering opportunities for potential strong returns.
• However, investors would be wise to remain cautious and expect further volatility and losses to accompany the high return potential of these asset classes.
• Inflexible, single-sector, benchmark-constrained credit implementation may leave investors too exposed to near-term volatility related to recession uncertainty.
• In contrast, flexible multi-sector bond strategies may help investors “average in” to higher yielding opportunities, while at the same time allowing them to remain nimble enough to increase or decrease their risk budget as market volatility evolves: ie, multi-sector is a useful middle-ground of the fixed income risk spectrum to “re-risk” core over weights and/or “de-risk” benchmark-constrained single-sector credit exposures.

PORTFOLIO CONSTRUCTION AND STRATEGY

TRENDS AND OPPORTUNITIES

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