As investors revisit their fixed income and cash strategies in what is a new dynamic rate environment, we provide an update on short duration fixed income and why we think the asset class looks compelling.
Central banks are continuing to respond to inflation running persistently higher than previously forecast. This is a significant focus area for fixed income investors who continue to monitor key underlying metrics such as rents and wage growth. The Federal Reserve, Bank of England and European Central Bank have all performed hawkish pivots in recent months, causing sharp rate selloffs and higher yields. The pace and size of future rate hikes, as well as the removal of quantitative easing, are therefore top of mind. Economic growth is expected to be robust in 2022 but slower versus the sharp rebound seen during the pandemic recovery of 2021. Given the rate market volatility and supply technicals, credit spreads have also experienced modest volatility over the near term. Over the long term, we remain constructive on high quality credit given the strong growth backdrop and robust bottom-up fundamentals. Additionally, geopolitical tensions pose concerns to risk assets with the potential to drive volatility higher.
We believe short duration may offer an attractive risk-adjusted opportunity as investors revisit their fixed income and cash strategies in the new dynamic rate environment. Short duration strategies are complementary to both cash and longer-dated fixed income allocations, typically offering both potentially lower volatility than longer duration bonds while preserving most of the carry. Moreover, short duration strategies offer the potential of higher yields compared to money market securities, in addition to greater diversification.
Many investors have also built up high levels of cash, often with relatively long investment horizons, and are seeking to optimise. We believe that active management may provide a performance advantage in today’s fast-moving environment. For example, light-footed, tactical positioning around central bank moves and a sharp focus on what is priced in versus our own view of the future can potentially drive outperformance.
We maintain our long-standing overweight view on credit, particularly on BBB-rated issuers which we believe offer attractive risk-adjusted potential. In more flexible strategies we continue to see select opportunities in emerging market corporates and sovereigns, high yield corporates as well as high-quality, low spread duration securitized instruments (e.g. non-agency mortgage-backed securities and collateralized loan obligations). At the sector level, fundamentals and technicals remain supportive for front-end investment grade credit and in 2022 we expect steadily improving credit profiles, elevated margins, and more upgrades, all of which point to potentially excess returns driven by carry and roll as opposed to spread compression. Euro short duration has become particularly interesting to investors seeking positive yields, and in the current environment we are tactically defensive.
Our Liquidity Solutions portfolio management team has deep expertise across the full spectrum of front end markets, managing over $690 billion1. In both funds and customised separately managed accounts we strive to deliver global, actively managed, balanced portfolios expertly constructed to provide exposure to diversified sources of return, with a focus on risk management. ESG is integrated into our fundamental credit process, and in many cases also portfolio objectives and construction. Our dedicated Liquidity Solutions portfolio management team invests with a multi-sector approach to ensure that our high caliber ideas from across our 300+ person global fixed income business are identified and appropriately implemented.
1. As of December 31, 2021