The return of earning interest

Over the past year, bonds failed to fulfil their role as a stabilising force within portfolios, despite their traditional use in asset allocation. This was due to the swift and unparalleled increase in interest rates, which led to substantial losses across fixed-income securities.

Even bonds that had favourable credit ratings, offered investors negligible yields that were close to zero and were unable to compensate for the price drops experienced across the bond market.

There was the sluggish response from central banks to excessive inflation, coupled with geopolitical uncertainties. Meanwhile diminished trading liquidity in capital markets from a tighter money supply, resulted in heightened interest rate spreads across all bond segments. These combined factors, ultimately caused bonds to suffer losses that were comparable to equities.

ChampionsNews: Looking ahead, does this present a unique opportunity to garner a consistent stream of income from interest-bearing securities?

The interest rate market is experiencing a revival as bonds once again offer substantial, reliable returns. For instance, long-dated government bonds in Germany and the US have reached levels not seen in over a decade. Despite the expected continuation of central bank interest rate hikes, this does not ensure stability in the bond markets. However, inverted yield curves and peaks in monetary depreciation rates indicate that monetary policy may not become excessively restrictive in a fragile economic climate. Furthermore, the already elevated valuations in riskier equity markets, in light of a looming recession and diminished earnings projections, adds to the appeal of bonds in this scenario.

In our opinion, a well-diversified portfolio comprising of individual investments with a high degree of granularity, sourced from a wide range of countries, issuers, and maturities, is crucial for making a successful investment, especially in an unpredictable bond market. Despite the recent turbulence, we still observe ample inefficiencies globally that offer more favourable returns when compared to domestic markets.

Bond prices have still not fully normalised, and borrowers have to pay significant underwriting incentives to their investors when offering new issues. Currently, regions such as Africa are largely excluded from capital markets due to regulatory restrictions imposed on entire investor groups over exaggerated default expectations and rating downgrades. However, those who can leverage this situation with a proactive investment strategy can reap the benefits of earning attractive interest rate premiums, particularly for bonds issued by financials and emerging market debt.

It is, therefore, advisable to hedge against interest rate risks, as last year's events showcased the severe impact that interest rate fluctuations can have. Additionally, considering the substantial depreciation of the Euro last year, the utilisation of forward exchange contracts in the bond portfolio, is also advisable.

ChampionsNews: Is investing beyond the Euro also worthwhile?

In stark contrast to equity investments that are diversified internationally, European investors often prefer to invest in bonds denominated in Euros, despite the other currency areas offer higher interest rates due to an overstated perception of currency volatility. To achieve necessary diversification, actively managed funds are the optimal solution. Our Capitulum Sustainable Local Currency Bond Fonds UI (ISIN DE000A2JF7Y2 (share class A)), which invests based on sustainability criteria, not only boasts an attractive portfolio with a high creditworthiness and short residual maturity to yield ratio, but has also demonstrated a balanced level of performance during last year's market turbulence, which is a rarity among investment products.