January 19, 2023 | 3 Minute Read
Trying to time a turn in the rate of inflation or the global growth outlook is always difficult. The pandemic and the war in Ukraine make it even more complex today. Fortunately, investors may not have to. That’s because the sharp rise in real or inflation-adjusted yields means that fixed income assets today are already offering the most attractive income and total return potential that we’ve seen in more than a decade. To put it simply, bonds are back. After the 2008 Global Financial Crisis, interest rates at zero or below forced investors to take on more risk to generate return. Now, with a mix of higher and stickier inflation, higher growth volatility and higher real yields, we’ve shifted from a regime in which There Is No Alternative (TINA) to equities and other risk assets to one in which There Are Reasonable Alternatives (TARA). The sheer speed of this shift has been stunning. As investors enter the new year, it may help to think about it this way: in late 2020, almost a year into the COVID-19 pandemic and more than a decade after the 2008 GFC, the total value of negative-yielding bonds around the world reached a record high of almost $18 trillion.1 That was the result of extraordinarily loose monetary policy in an era of negligible inflation and anemic economic growth in major economies such as the eurozone and Japan. Today, policy shifts at major central banks to counter inflation have caused negative-yielding debt to largely disappear. Across geographies and sectors, yields are near their highest levels in a decade, offering attractive income and total return potential.
Source: Bloomberg, Macrobond, Goldman Sachs Asset Management. As of January 17, 2022.2 For illustrative purposes only. Past performance does not predict future returns and does not guarantee future results, which may vary.
Even so, we are living in an increasingly complex and unpredictable world, and we believe it’s important that investors embrace a selective, quality-first approach in their fixed income allocations until there is more clarity on the global growth outlook.
With the precise path of inflation and economic growth uncertain, we see value in high-quality short-duration US and European corporate bonds. These securities offer yields that are considerably higher than the still-low savings rates on bank deposits and offer investors attractive potential returns without the need to take on undue interest rate or credit risk. Corporate fundamentals for both US and European bonds are robust, leverage ratios are contained, interest coverage ratios are high and financing needs are limited, since many companies raised debt in 2021 when rates were lower.
Having entered 2022 with historically tight spreads—the result of Fed purchases—agency mortgage-backed securities (MBS) exited the year with the widest spread level outside of the COVID-19 stress period and the 2008 GFC. We think lower rate volatility combined with less new supply will lead to a performance turnaround in 2023. Low cyclicality also makes the asset class, which has limited credit risk owing to its implicit or explicit government guarantee, attractive in an environment of decelerating growth.
We believe private credit can be a powerful complement to traditional fixed income strategies, offering incremental income generation, return enhancement and diversification. As businesses adjust to a higher-for-longer cost of capital environment, current yield levels mean that investors are getting paid well to be a lender. The floating-rate structure of most private loans offers valuable protection against inflation, while the ability of lenders to conduct in-depth diligence on borrowers differentiates these assets from comparable public fixed income securities. Private and public fixed income opportunities come with different risks, with the former considerably less liquid. But in our view, the risk-adjusted return potential associated with these direct lending opportunities is strong, and investment opportunities are likely to grow as more companies tap private credit markets to finance deals.
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1Macrobond and Bloomberg, as of November 22, 2022
2US 10 Year TIPS Bond , Germany 10 Year Government Bond, Spain 10 Year Government Bond, United Kingdom 10 Year Government Bond, US 10 Year Government Bond, Italy 10 Year Government Bond, ICE BofAML Euro Corporate Index, ICE BofAML US Fixed Rate Agency CMBS Index, ICE BofAML Mortgage Backed Securities Index, ICE BofAML US Corporate Index, ICE BofAML Fixed Rate Asset Backed Securities Index, J.P. Morgan EMBI Global Diversified, ICE BofAML Euro High Yield Index.
Energy security is the uninterrupted availability of energy sources at an affordable price.
Inflation is the rate at which prices for goods and services rise.
Risk assets those with a high degree of risk and volatility, such as such as equities, high-yield credit, commodities, and currencies.
Alpha measures the difference between a portfolio’s actual return and its expected return given its risk level as measured by its beta.
Beta measures the historical market risk of a portfolio or the volatility of a portfolio relative to an underlying index over a defined historical period of time.
Growth-oriented refers to areas of the market more likely to realize high earnings growth in the future and likely trade at a higher price relative to their earnings than the broader market.
Value-oriented refers to areas of the market less likely to realize earnings high growth in the future and likely trade at a lower price relative to their earnings than the broader market.
The “right side of disruption” refers to companies that in our view are aligned with key secular growth trends and/or are creating new innovative solutions.
Green economy refers to investments leading the climate transition.
Equity risk premia refer to the excess return earned by an investor when they invest in the stock market over a risk-free rate.
TINA stands for There Is No Alternative.
TARA stand for There Are Reasonable Alternatives.
Speculative-grade fixed income refers to high yield fixed income.
Duration measures the sensitivity of the price of a fixed income investment to a change in interest rates.
Short duration refers to a bond with a small amount of time to maturity.
Treasuries refers to US Treasury debt obligations.
Inflation-adjusted yields refer to the measure of return that takes into account the time period's inflation rate.
Innovation-oriented equities refer to companies that offer innovative solutions and are in line with long-term secular growth trends, such as technological innovation, environmental sustainability, future health care, and the new-age consumer.
Liquid alternatives are alternative mutual funds that often have characteristics similar to hedge funds but are public vehicles that can be traded easily.
Green bonds are fixed income investments with proceeds used to finance projects with dedicated environmental impact
GDP stands for gross domestic product and refers to the value of finished goods and services produced within a country's borders over one year.
Median return is the middle return in a sorted list of each individual security's return.
Risk premia refer to the amount by which the return of a risky asset is expected to outperform the known return on a risk-free asset.
Leverage ratio is a financial measurement that assesses the ability of a company to meet its financial obligations.
Interest coverage ratio is a measurement used to determine how easily a company can pay interest on its outstanding debt.
Drawdown is a peak-to-trough decline during a specific period for an investment, trading account, or fund.
Low quality companies would rank low based on low return on equity (LOE), high leverage or debt to equity, and unstable earnings.
German 10Y is a bond that reflects the yield received on government bonds issued by the German government maturing in 10 years.
Spain 10Y is a bond that reflects the yield received on government bonds issued by the Spanish government maturing in 10 years.
US 10Y Treasury is a bond that reflects the yield received on government bonds issued by the United States government maturing in 10 years.
United Kingdom 10Y is a bond that reflects the yield received on government bonds issued by the UK government maturing in 10 years.
Italy 10Y reflects the yield received on government bonds issued by the Italian government maturing in 10 years.
US 2Y Treasury is a bond that reflects the yield received on government bonds issued by the United States government maturing in 10 years.
ICE BofA US High Yield Index value, which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market.
ICE BofA Euro Corporate Index value, which tracks the performance of Euro dollar denominated investment grade rated corporate debt.
ICE BofA High Yield Master II OAS uses an index of bonds that are below investment grade (those rated BB or below).
EMBI (Emerging Market Bond Index) is JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries. The Global Diversified limits the weights of countries with larger debt stocks by only including a specified portion of these countries' eligible current face amounts of debt outstanding.
ICE BofA US Corporate Index, which tracks the performance of US dollar denominated investment grade rated corporate debt publicly issued in the US domestic market.
All investing is subject to risk, including the possible loss of the money you invest.
Equity securities are more volatile than bonds and subject to greater risks. Dividends are not guaranteed and a company’s future ability to pay dividends may be limited.
Bonds are subject to interest rate, price and credit risks. Prices tend to be inversely affected by changes in interest rates. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds.
Investments in fixed income securities are subject to the risks associated with debt securities including credit and interest rate risk.
Investments in foreign securities entail special risks such as currency, political, economic, and market risks. These risks are heightened in emerging markets.
Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
High-yield, lower-rated securities involve greater price volatility and present greater credit risks than higher-rated fixed income securities.
Private equity investments are speculative, highly illiquid, involve a high degree of risk, have high fees and expenses that could reduce returns, and subject to the possibility of partial or total loss of fund capital; they are, therefore, intended for experienced and sophisticated long-term investors who can accept such risks.
Alternative Investments often engage in leverage and other investment practices that are extremely speculative and involve a high degree of risk. Such practices may increase the volatility of performance and the risk of investment loss, including the loss of the entire amount that is invested. There may be conflicts of interest relating to the Alternative Investment and its service providers, including Goldman Sachs and its affiliates. Similarly, interests in an Alternative Investment are highly illiquid and generally are not transferable without the consent of the sponsor, and applicable securities and tax laws will limit transfers.
An investment in real estate securities is subject to greater price volatility and the special risks associated with direct ownership of real estate.
Hedge funds and other private investment funds (collectively, “Alternative Investments”) are subject to less regulation than other types of pooled investment vehicles such as mutual funds. Alternative Investments may impose significant fees, including incentive fees that are based upon a percentage of the realized and unrealized gains and an individual’s net returns may differ significantly from actual returns. Such fees may offset all or a significant portion of such Alternative Investment’s trading profits. Alternative Investments are not required to provide periodic pricing or valuation information. Investors may have limited rights with respect to their investments, including limited voting rights and participation in the management of such Alternative Investments.
The above are not an exhaustive list of potential risks. There may be additional risks that should be considered before any investment decision.
The views expressed herein are as January 17, 2023 and subject to change in the future. Individual portfolio management teams for Goldman Sachs Asset Management may have views and opinions and/or make investment decisions that, in certain instances, may not always be consistent with the views and opinions expressed herein.
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Date of First Use: January 19, 2023 303206-OTU-1729696