Just as tectonic plate movements can trigger earthquakes and reshape landscapes, financial tectonics shifts are being driven by three forces that are compelling investors to rethink their approach to bond markets: the fragmentation of the global economy, fiscal indiscipline, and the tsunami of passive investing.
1. The fragmentation of the global economy
The 2020 Covid-19 pandemic accelerated a trend that began with Brexit: a retreat into protectionism and the abandonment of the 'happy globalisation' narrative. Tariffs, unilateralism, and the resurgence of armed conflicts have created a less business-friendly environment for global trade.
2. Fiscal indiscipline
Before 2020, fiscal orthodoxy was the prevailing principle. The pandemic, however, ushered in a "whatever it takes" era, pushing governments onto unsecure fiscal trajectories that now limit their ability to support their economies. As a result, central banks have taken on an even more pivotal role in stabilizing markets.
3. The tsunami of passive investing
Today, nearly 40% of the bond market is dominated by index funds. While this phenomenon was once seen as a contributor to market liquidity, it now introduces risks: concentrated flows, weakened price discovery, and heightened volatility during market shocks.
How can investors adapt to these forces?
Adapting to the fragmentation of the global economy requires putting fundamental analysis back at the centre of investment decisions and moving away from benchmark dependency. Benchmarks typically lock investments into rigid allocations, limiting flexibility and stifling value creation. A 'benchmark-agnostic' approach allows for more dynamic regional and sectoral allocations that are better suited to the new economic realities.
Integrating fiscal indiscipline into investment strategies has become essential. Recent episodes of bond market volatility have been fuelled by growing fiscal concerns. A top-down supervision of these macroeconomic risks is now imperative. This shift also calls for a reassessment of sovereign bonds' role in portfolios, with a growing preference for credit, which is better aligned with evolving economic and financial dynamics.
The passive investing tsunami presents a unique opportunity for active investors. By adopting a benchmark-free approach, exploring price arbitrage opportunities, and optimizing portfolio income, active investors can capitalize on market inefficiencies and drive value creation.
What solutions does UBP provide?
In this new era of financial tectonics, adaptability and a forward-looking approach are the keys to navigating the shifting landscape of bond markets. At UBP, we address this with our income strategy.
The genesis of this strategy is anchored in a conviction and an observation. The conviction is that post-pandemic markets have entered a new cycle marked by increased volatility from interest rates that favours income and carry strategies.
Investors are increasingly seeking strategies that minimize default risk while targeting income levels higher than those offered by investment-grade bonds.
Additionally, investors using an aggregate index as a benchmark are looking to diversify away from sovereign bond risk due to deteriorating government balance sheets.
Our income strategy was envisioned by the Global & Absolute Return Fixed Income team with these principles in mind.
It is designed as a core income approach, focusing on maintaining an investment grade risk/reward profile. The portfolio keeps an average rating of at least BBB- at all times. The strategy serves as a core investment-grade portfolio within an asset allocation.
As a multi-sector income strategy, it avoids traditional benchmark-centric construction, instead investing in global fixed income markets based on the Global and Absolute Return Fixed Income team’s fundamental analysis of the market segments, industry sectors and issuers. The portfolio construction balances two key objectives: optimising yield while maintaining a cautious approach to default risk.
This actively managed strategy is built on three pillars: fundamental analysis accounting for ~50%, relative value analysis for ~30%, and top-down oversight for ~20%. Fundamental analysis is performed by the team’s experts across each market segment, comprising 16 portfolio managers/analysts, and traders. Relative value analysis is continuously conducted to identify opportunities and capitalise on shifts in market valuations. The investment team applies a top-down oversight overlay, serving as a crucial risk management layer.
Are you interested in learning more about bond markets?
Please contact us to find out more on how we can work together on your goals in the best possible way.
