How to invest in fixed income amid uncertainty

It’s a time of uncertainty in the second half of 2023. While inflation is cooling, central banks are concerned that it is not coming down as quickly as it should. This leaves investors guessing about the rate hike cycle ahead. 

Fixed income has been in vogue this year, but amid uncertainty, how should investors position themselves for the rest of the year to generate a steady income through bonds? What is the recommended allocation to navigate the risk and market volatility amid dynamic conditions? Do Asian investors allocate too much to cash? How should investors optimise their portfolios for their long-term retirement needs?   

We are pleased to hear from Jonathan Liang, J.P. Morgan Asset Management’s Asia ex-Japan head of investment specialists within the global fixed income, currency, and commodities group. Jonathan discusses his view on different segments within the bond universe,  J.P. Morgan's call on the high-yield bond market, and shares insights on how much duration risk bond investors should be taking on now.

Watch the interview

Chapters

‍00:00 – Introduction

‍01:02 – What are some key uncertainties over inflation that, if resolved, will help to clarify the Fed’s rate path in the second half of 2023?

‍02:28 – Given this current environment, what are some segments within the bond universe that you would recommend to investors?

‍03:30 – How much duration risk should bond investors be taking on now?

‍04:34 – What is J.P. Morgan’s call on the high-yield segment? And how should investors position themselves if they are keen to take some exposure here?

‍06:33 – How can investors better position their portfolio allocation amid these dynamic times?

‍07:48 – Are investors in Asia over-allocated to cash? If so, is there a recommended allocation that investors should be mindful of, so that their portfolios are optimised for their long-term retirement needs?

Highlights from the interview

This section is extracted from the interview without any modifications to the original meaning. If you wish to learn about the complete content, please watch the full video above. Third party speakers’ opinion in the interview does not represent Endowus, Endowus accepts no responsibility or liability as to its completeness or accuracy.

Here are some key snippets from the conversation between Edwin Ho, Client Advisor Lead at Endowus HK, and Jonathan Liang, Head of Fixed Income Investment Specialists, Asia ex-Japan at J.P. Morgan Asset Management.

Key uncertainties over inflation

Edwin: What are some key uncertainties over inflation that, if resolved, will help to clarify the Fed’s rate path in the second half of 2023?

Jonathan: The first thing is that the level of inflation has actually come off quite a bit. But the speed of inflation moving down is still not as the Fed would like. The second thing is the labour market in America remains very strong. Average hourly earnings are still moving up at a pretty healthy pace which is still putting upward pressure on inflation. So we think that a further deceleration in the labour markets will also be necessary.

But as we continue to hike rates in July and maybe one more time in September, we think that is going to start to impact the real economy as well as the labour markets.

Recommended segments to secure income from bonds

Edwin: Given this current environment, what are some segments within the bond universe that you would recommend to investors?

Jonathan: As we look across the fixed income universe, the clear sector that we think is showing some value is actually agency mortgage-backed securities. Now these securities are issued by U.S. housing agencies, Fannie Mae and Freddie Mac and they in turn are backed by the US government. So these are AAA-rated securities with no credit risk. 

They also provide very healthy high-quality duration during a period where if the market starts to price in the Fed funds rate pause and then in the future, rate cuts, then these bonds, we think, will stand to benefit.

Understanding duration and rate hike cycles

Edwin: If we may dive a little deeper into the specifics, how much duration risk should bond investors be taking on now? 

Jonathan: We think investors should take on some duration at this point in time given that we are very near the end of the Fed fund rate hike cycle this time around, and every time when the Fed pauses, duration outperforms quite a bit. In fact, if you look at the last six rate hike cycles and in subsequent pauses, every time when the Fed pauses in the subsequent 12 months, high-quality duration has delivered double-digit type returns in the subsequent 12 months.

Generating income from the high-yield bond market

Edwin: There also remains some debate on whether the high-yield bond market is attractive today. What is J.P. Morgan’s call on this particular segment? And how should investors position themselves if they are keen to take some exposure here?

Jonathan: On the one hand, fundamentals are actually pretty decent in US high yield right now. Leverage ratios on balance sheets have come off quite a bit and right now there aren't a lot of bonds maturing between now and the end of 2024. So while default rates may rise from here as we enter an economic slowdown and even a recession, we think the default rate probably would not go up too much.

The issue though is that valuations right now are definitely not pricing in an economic slowdown or recession. So from a valuation perspective, there are some risks. So if investors were to take some exposure in high yield, we would recommend that they stay in high quality within the high-yield market.

Portfolio allocation amid dynamic conditions

Edwin: Bond investors have different investment goals and needs, such as capital preservation. They are also working through different scenarios of expected rate changes. So how can investors better position their portfolio allocation amid these dynamic considerations?

Jonathan: We think it is very important to take a dynamic and benchmark-unaware approach to fixed income investing because we are entering an inflection point in the monetary policy cycle as well as the economic cycle. So, you need to be very active and dynamic in the allocation of your portfolio during this inflection point. At this very moment, we would skew towards having high-quality intermediate duration and try to hedge some of the beta within your high allocation and allocate to high-quality sectors like agency MBS. But later on, that might change. We would currently advocate a U-curve steepener, but later on, if the U-curve were to be uninverted then we would need to change the position as well.

Rethinking cash allocation for retirement needs

Edwin: We are seeing continued strong interest in fixed deposits and money market funds among Asian investors. Are investors in Asia over-allocating to cash instruments as compared with the West? If so, is there a recommended allocation that investors should be mindful of so that their portfolio is optimised for their long-term retirement needs?

Jonathan: When we look at our business globally this year, we see that flows in the US have been very, very strong into our fixed income platform. But in Asia, it's also positive but not as strong as what we're seeing in the US this year. So your observation is true that maybe Western investors are more fully allocated to fixed income compared to Asian investors, who currently still favour fixed deposit money and money market funds. 

But while money market funds give you a pretty decent yield today, what they do not provide is potential capital appreciation. In the last six rate hike cycles in America, every time the Fed pauses, high quality duration in fixed income has delivered double-digit type returns in the subsequent 12 months. So we think having a (higher) allocation to fixed income than what Asian investors currently have is probably appropriate. But in the longer term, to properly plan for retirement goals, proper diversification, and a balance between growth assets, safety assets, and high-yielding assets will be very important to achieve their long-term retirement goals.

Invest in fixed income with a diversified approach

Want to learn more about fixed income investments? Watch the replay of our webinar with J.P. Morgan Head of Fixed Income Investment Specialists, Asia ex-Japan Jonathan Liang, Elisa Ng, Head of Hong Kong for J.P. Morgan Asset Management, Endowus Chairman & Chief Investment Officer Samuel Rhee, and Director of Investment Research at Endowus Min Axthelm.

In the midst of inflation and rising interest rates, the market outlook remains uncertain. Fixed-income products have gained popularity among investors for their ability to mitigate overall portfolio volatility and act as diversifiers to stocks. Today, Hong Kong investors have access to a wide range of fixed-income funds managed by top-tier fund managers, curated through Endowus' rigorous SMART+ process. 

Click here to learn more about bonds. Explore our Fund Smart platform if you’re keen on investing in Best-In-Class fixed income funds across various investment themes.

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To get started with Endowus HK, click here.

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