Note: A description of ‘yield-to-maturity‘ and how it is calculated can be found at the end of this article.
For active bond investors, one of the advantages of difficult markets is that they make everything cheaper: you don’t need to take unnecessary risks in search of an appealing headline return – because the market has sold off enough that even bonds issued by stable, resilient companies are offering yields the likes of which investors could only dream of for most of the past decade.
Despite my underlying bullishness, I’m sure that 2023 will be far from plain selling for high yield bond markets. After all, yields are high for a good reason. The economic outlook is grim and that means more companies will default on their debt. This can feel like a scary time to be investing, so markets are right to demand more yield by way of compensation for putting capital at risk.
As active investors, credit analysis is a big part of our job: trying to understand what current bond valuations are telling us about the consensus view of the market, and assessing whether we think bond purchasers are being over- or under-compensated for the risk of holding a given bond. The detailed process of analysing individual companies to understand their strengths and weaknesses can often be undervalued when markets are rising, but is critical to delivering returns in tougher times.
These remain material risks that cannot be ignored, but we’d argue that pessimism is already baked into European bond valuations and that Europe now presents a lot of opportunities for bond investors, if investment is done selectively: our preference is for the euro-denominated bonds of high quality global companies (which are not necessarily even headquartered in Europe).
In contrast, US bonds – especially the high yield part of the market – haven’t performed as poorly as bond markets elsewhere in the world and as a result US bonds now look relatively expensive to us. Given their outperformance, I would expect to see more pressure on US high yield bonds during the course of 2023 as the global economic reality hits home, so I believe caution is merited.
The bottom line is that I expect the economic news in 2023 to be poor, but that needn’t translate into another tough year for fixed income. In fact, at current valuations, I feel more optimistic than I have done for years that investors in fixed income could make attractive returns next year. But it won’t be smooth or easy, and active investors will need to make sure they do all their homework and invest smartly to identify the compelling opportunities that bear markets deliver.
Definition: Yield to maturity YTM) is the total return anticipated on a bond if the bond is held until it matures, expressed as an annual rate. This includes both the income from the bond, assuming the bond issuer does not default on its debt, and any capital gain or loss there might be when the bond matures. It is therefore a theoretical projection and not a guarantee. It is also different to the quoted yield of any given bond fund, which is typically expressed as an historic yield, meaning it is based on income payments already made in the previous year.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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