The euro investment-grade (IG) credit market has historically delivered an average annual return of +2.8% since 2005. However, the past five years have proven particularly challenging, with returns stagnating at around 0.0%. This period was marked by a sharp 15% drawdown in 2022, driven by the energy crisis and surging inflation.
These headwinds have resulted in a cumulative opportunity cost of -16% over the past five years, compared with the asset class’s historical average return over the past 20 years. For investors relying on euro IG as a core fixed-income allocation, the question now is: how can they recover from this significant drag on performance?
Euro investment grade market
Two key options stand out:
Option #1: Remain invested in the euro IG market.
With current yields hovering around 3%, staying invested in euro IG could provide a steady income stream. However, it would take approximately five years just to recoup the returns lost over the last five years, leaving investors still trailing behind the long-term historical performance of the euro IG market.
Option #2: Position for yield compression.
Another potential strategy is to remain invested in euro IG while anticipating yield compression. Given the inverse relationship between yields and prices, a capital gain of +16% would require a yield compression of 350 basis points. However, this scenario appears unlikely, as it would imply a negative yield of -0.5% for the asset class (assuming a duration of 4.5 years).
Thinking beyond the benchmark and optimising income with UBP’s Income Strategy
To overcome the limitations of traditional euro IG allocations, investors might consider adopting a more flexible approach to credit markets: by moving away from benchmark constraints and exploiting a larger opportunity set, it may be possible to construct a multi-sector portfolio that maintains an investment-grade profile while enhancing yield potential.
This can be achieved by allocating globally to segments such as corporate bonds, subordinated debt, or collateralised loan obligations (CLOs) while maintaining an investment-grade profile in the portfolio. Such a strategy could generate an income of more than 4% in euros, optimising carry, and improving the risk-return profile of a core fixed-income allocation.
To build a comparable income strategy, UBP’s Global & Absolute Return Fixed Income team employs a disciplined, multi-faceted approach. At its core lies fundamental analysis, conducted by the team’s seasoned experts, who rigorously assess issuers based on their current credit quality and projected credit trajectory.
After three years of solid performance, the strategy has now exceeded the milestone of USD 1 billion in assets under management. More generally, we are deeply grateful for the trust and confidence our clients have placed in our fixed income franchise.
The portfolio’s risk/return profile is further optimised through meticulous relative value analysis. This process informs rebalancing decisions both across and within the portfolio’s investment segments, driven by price arbitrage.
Last, the team’s macroeconomic analyses play a pivotal role in managing and mitigating major portfolio risks. By identifying key macroeconomic trends and opportunities, the team reinforces the portfolio’s core positioning while navigating potential challenges.
A robust governance framework, anchored in committee-led decision-making, ensures a disciplined and methodical approach to portfolio construction and management
UBP’s global fixed income platform brings together eighteen seasoned professionals, over USD 22 billion in assets, and an investment philosophy that has remained consistent since 2007.
The same solution would also apply to sterling- and Swiss-franc-based investors. A comparable strategy maintaining an investment-grade rating could deliver a hedged yield of 6.0% in GBP and 2.0% in CHF. This approach offers a notable premium over the sterling investment-grade credit market, which currently yields 4.7%, and the Swiss bond market, where yields stand at a modest 0.6%.
Associated Risks: The investment strategies mentioned in this article involve risks, including credit risk, liquidity risk, and market risk. Investors should be aware that the value of their investment may fluctuate, and they may not recover the full amount of their invested capital. Past performance is not a guide for current or future results. Any forecast, projection or target, where provided, is indicative only and is not guaranteed in any way.
The legal disclaimer of Union Bancaire Privée is available at the following link : https://www.ubp.com/en/legal-aspects/terms-of-use