While forecasting a better outlook for equities than fixed income, Nordea’s multi assets team expects fundamentals for corporate bonds to remain healthy in 2022.
Given the low yield environment, Asbjørn Trolle Hansen, head of the multi assets team at Nordea, said the team has retained its cautious stance within the fixed income space. However much of this caution relates to the prospects for government bonds in an inflationary environment.
“Overall, we still see duration premia being at rather unattractive levels and the diversification benefits investors could harvest in the past from government bonds have been continuously falling,” said Trolle Hansen.
Unlike government bonds, Trolle Hansen noted that credit is less hampered by rising inflation, as credit performance – just like equities – is often positively correlated with inflation. This is because inflation improves corporate earnings and the borrower’s ability to service debt.
“Market concerns of tighter monetary policy have not really had an adverse impact on credit so far,” he said. “Credit fundamentals remain healthy due to solid earnings and limited corporate expenditures, which boost corporate liquidity and company cash holdings.”
Interesting alternative
As a result, Trolle Hansen said Nordea’s multi assets team is seeing very few defaults at present, and according to expectations among senior credit officers and rating agencies, defaults are likely to remain subdued compared with historical levels for the next couple of years.
“With overall fixed income markets currently showing little appetite for duration-sensitive government bonds, corporate bonds become an interesting alternative, since current tight spreads are counterbalanced by a low likelihood of experiencing a default,” he said.
From a longer-term standpoint, Trolle Hansen said it is key to highlight that expected returns for the next decade will be “significantly” different to what investors have seen over the course of the previous one.
He said: “We anticipate shrinking expectations taking a toll across the traditional asset class spectrum and this is especially true for fixed income, where there are low and even negative expected return for the asset class going forward. In contrast, equities will still be very much in the spotlight as the main source of returns for the coming years.
“Here, the question remains whether they will be able to deliver those expected returns without any significant increase in volatility or any sizeable correction.”
Similarities
So even though the world is very different from what it was before the pandemic, for Trolle Hansen, the dilemma for investors appears to be “eerily similar”.
With fixed income’s diversification potential being significantly decreased and government bonds appearing to offer little cushion for comfort, he said there is a strong need for investors to have other, alternative tools available to be able to diversify equity beta risk within their portfolios.
“This has become more pressing than ever, particularly as the traditional diversification tools that investors have been used to in the past have not been working anymore in recent equity market sell-offs,” said Trolle Hansen.
“One example is the use of defensive currencies, selected on quality characteristics and attractive valuation. During recent selloffs, defensive currencies have provided superior downside protection compared to many traditional bond sources.
