Fixed income: performance drivers as peak rates approach

As the US rate-hiking cycle nears its zenith, two positive drivers for fixed-income investment are coming into view: stronger performance prospects for sovereign bonds and the return of the low correlation between duration and credit risk. In the Q2 issue of Alphorum, we assess these dynamics while providing new fundamental and portfolio-construction insights on fallen-angel bonds. Key points include:

• Two upsides of peaking rates. First, given the trend established in hiking cycles dating back to 1995, Treasuries are likely to outperform¹ cash for up to 18 months after the final interest-rate hike. Second, the lack of correlation between duration and credit risk – absent during the aggressive tightening of 2022 – is normalising, enabling carry to help absorb shocks and rates to support returns amid an economic slowdown
• Why do angels fall – and is it always bad news? Maybe it’s a tough business cycle, or the result of a one-off shock. Perhaps a bond’s downgrade from investment grade is due to the issuer’s intentional change in financial policy. Whatever the reason, understanding why a fallen angel has descended is essential to determining whether these new entrants to the high-yield universe are mispriced and likely to pull to par, delivering returns
• Green stimulus heightens US, European climate risk and opportunity. The Green Deal Industrial Plan from the European Union aims to simplify regulation towards decarbonising energy and industry while diversifying sources of critical materials and technology. Like the US Inflation Reduction Act, it ultimately aims to accelerate progress towards climate goals, and both stand to heighten transitional risks – and opportunities – for credit investors
• A new hedge against investment-grade losses? Fallen angels can be used as a diversifying, more convex or generally up-in-quality high-yield exposure. But we believe they can also complement investment-grade portfolios. Our analysis shows that a relatively small allocation can potentially recover the losses incurred when bonds downgraded to high yield become forced sales

To read more, please download the Q2 issue of Alphorum.

1 Past performance is not a guarantee of future results.

FOR PROFESSIONAL INVESTORS ONLY
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name.
This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited  which is authorized and regulated by the FCA. ©2024 Lombard Odier IM. All rights reserved.