With markets looking expensive and credit spreads tightening, major investors have been actively reducing their exposure to riskier corporate debt amid concerns that recent market rallies have left precious little buffer against potential downturns.
In light of limited additional reward for taking on additional risk, as credit spreads narrow, asset managers are unsurprisingly shifting toward more defensive strategies.
According to Chris Iggo, CIO at AXA IM, who manages over €465 billion (A$830.6 billion) in fixed income, there’s been an increase in long-term bond yields and evidence that government bonds have cheapened relative to other assets.
Greater risk premium in government bonds
What's the widening gap between government bond yields against the swaps market is telling us, adds Iggo is there’s more of a risk premium in government bonds, with government bond yield curves continuing to steepen.
Iggo currently favours short-duration strategies across different fixed income asset classes, including high yield, investment grade credit, government bonds and infrastructure-linked bonds.
“Although we’ve got to more normal levels in bond markets, there’s more to go in terms of that yield curve steepening,” said Iggo.
“Whereas with short duration – bonds with a maturity of around three years – you’re getting the credit spread (additional yield) and your exposure to adverse movements in interest rates is much more limited; So drawdowns will be less if there’s another broad move higher in interest rates.”
European assets and equities
Iggo’s preference at the moment is for assets that are not expensive, and on the equity side, he prefers European assets and equities that have much lower valuations.
“On the fixed income side – especially in credit - we focus on good quality companies that we think are able to meet their obligations in terms of interest payments, where the risk of downgrade or default is very low: So it’s all about quality and income growth,” he said.
Interestingly, Iggo expects bonds to provide a hedge if share markets crash, with bond yields – following the rate reset by central banks – especially at the medium to long part of the yield curve now in a more fundamentally justifiable range.
“As a result, bonds can continue to play a traditional role within portfolios, firstly to provide income and secondly to be a diversifying asset to equities,” he noted.
However, he expects market sentiment towards a sub-asset class like private credit to deteriorate in light of recent high-profile defaults like First Brands in the U.S.
The trouble with private credit, adds Iggo that a lot of investors are flying dark, given that the availability of data isn’t as rich as it is in the public bond markets.
Fixed income demand surges
Meanwhile, after a year marked by volatility, fixed income is moving back into focus as investors look for safety and stable returns.
With cash rates falling and equity markets looking fully priced, demand for income products has risen sharply.
Darren Connolly, CEO of InvestmentMarkets, said the trend reflects a broader shift in investor behaviour.
“Investors have enjoyed higher cash returns in recent years, but as those rates fall away, they are looking for alternatives. Fixed income is emerging as a key part of that search, particularly for investors who want to protect capital and maintain income levels,” he said.
Demand for long-dated fixed-rate bonds
Cameron Window, Executive Director at Income Asset Management (IAM), said demand has been strongest for long-dated fixed-rate bonds.
Window notes banks have been issuing 10-year paper in the 5.5 to 6.5% range, and those deals are oversubscribed many times over.
“There’s a huge amount of money sitting on the sidelines, and when investors see the chance to lock in future income at those levels, they are jumping all over it.”
Window believes access remains one of the biggest differentiators in the asset class.
“Many investors default to funds or ETFs for fixed income exposure, but direct access gives you control. You know exactly what you hold and you can express your own view on interest rates,” he said.
One example is a recent Foxtel syndicated loan, issued after its acquisition by global sports provider DAZN.
It was a senior secured facility paying bank bill swap rate plus 5.00%-plus, effectively delivering 9%-plus.
For wholesale investors, that’s a high-yielding, institutionally-backed deal with meaningful asset security,” Window said.
Bonds no longer viewed as just defensive
Meanwhile, Connolly believes this type of diversification is increasingly attractive to self-directed investors, with fixed income having long been overlooked in private portfolios, often due to being seen as complex or hard to access.
“But what we’re seeing now is investors realising that bonds and loans aren’t just defensive, they can be a meaningful source of yield and liquidity, particularly when equity markets look stretched,” he said.
For conservative investors, IAM emphasises investment-grade products, yielding around 5.5 to 6.5%, with strong liquidity and low risk.
For balanced investors, higher-yielding bonds and loans in sectors like mining, infrastructure, and non-bank lending can lift overall returns while maintaining diversification.
Fixed income outlook
Looking ahead, Window believes the outlook for fixed income is anything but dull.
“With interest rates expected to continue to fall, we know bond prices will rise. That gives investors not just steady income but also the potential for capital gains,” he said.
At the same time, Window notes the phasing out of listed hybrids is forcing billions of dollars to find a new home, and he’s witnessing that money flow toward opportunities in this space.
Meantime, Connolly echoes a similar sentiment about conditions aligning for fixed income to play a bigger role.
“Fixed income is the ballast in portfolios, the part that lets investors, particularly retirees, sleep at night. It may have the reputation of being boring, but right now, for many, boring looks very appealing,” he said.
Corporate bond update
Meanwhile, in Australian corporate bond issue news:
- Ampol is taking indications of interest in a 30-year, non-call 8.25 (30NC8.25) subordinated note deal with price guidance of 225-230bps over 3-month BBSW
- Great Southern Bank has launched a three-year senior unsecured, FRN priced at 120 basis points over semi quarterly swap
- Orix Australia has launched a three-year senior unsecured, FRN priced at 100 basis points over 3-month BBSW
- Region Retail Trust has mandated a six-year senior unsecured fixed-rate bond
- ANU has mandated a five-year senior unsecured fixed-rate bond
- Victoria Power Networks Finance raised $750m in a dual tranche deal:
- A $450m fixed rate tranche with a 4.714% coupon
- A $300m floating rate tranche paying 107bps over 3-month BBSW
- Stockland launched a 10-year senior unsecured deal with price guidance of 150bps over semi quarterly swap
- Australian Military Bank priced a $20 million 10.25NC5.25 at 205bps over 3-month BBSW
- Orix Australia has launched a three-year senior unsecured, FRN priced at 100 basis points over 3-month BBSW
- Weir Group priced a $400m inaugural 5.25-year senior unsecured deal at 165bps over semi quarterly swap
