Bond markets: Flexibility, a solution for all market conditions 

The persistence of risk factors favours absolute return investment strategies, whose flexibility and diversification of performance sources are real assets.

The summer did not dispel the uncertainties, far from it. As talks for an Iran-US peace deal remain fragile since the ceasefire broke down in July, geopolitical tensions continue to weigh on the global economy and financial markets. 

With the resurgence of energy price shock risks, inflationary pressures and interest rate volatility, an absolute return strategy can deliver return and protection  within fixed income portfolios. Without being constrained by a benchmark, this management style explores a very broad investment universe: government bonds, corporate bonds, variable rates, convertibles, derivative instruments... Access to such a wide range of instruments makes it possible to combine complementary performance and diversification drivers, regardless of market cycles.  

According to this approach, it may be appropriate today to combine bond carry – holding securities until their maturity – with agility in credit allocation: participation in the primary market, selection of high-quality issuers, mobility in terms of seniority of securities and rating categories.

Sovereign bonds remain supported by what we view as attractive yield levels. Fully integrating inflationary pressures, the sharp rise in interest rates since the outbreak of the Middle East conflict has led to a steepening of the short end of the curve. In this environment, carry on short maturities – 2 to 4 years – can help to capture short-term yields without increasing risk exposure.

Inflation Swaps and Selectivity 

While short duration positioning provides some protection, an active approach to inflation-linked instruments also makes sense: using inflation swaps¹,  for example, can help to lower overall volatility in bond portfolios. This proved to be particularly beneficial in the first half of the year, when sovereign yields underwent a significant correction and lost their safe haven status. 

The credit segment experienced a different trajectory, with no shock to valuation levels. The asset class overall was quite stable, only the lower rated names CCC and B² suffered. And spreads are now at the same level as January, pre-conflict, even though the macroeconomic environment has deteriorated. We favour flexible allocation and stock-picking, targeting the most robust risk-adjusted return profiles.

Financial issuers demonstrate solid fundamentals and valuation levels that are still attractive, in our opinion. This is particularly the case in the banking sector in Italy and Eastern Europe, where consolidation moves could offer bond-picking opportunities. Conversely, we are steering clear of the most cyclical sectors – European automotive, chemicals, retail – which are currently exposed to the economic downturn.

As the final quarter of the year begins, we are maintaining our forecast of moderate but resilient global economic growth, while increasing the probability of adverse scenarios. In this context, absolute return offers an effective tool to diversify bond portfolios.