2024 is well on its way and investors are looking for the right investment to carry them throughout the year. Juan Nozal, fixed income portfolio manager at MAPFRE Asset Management, thinks fixed-income securities could be the answer.
Patrick Brusnahan: How long have you been at MAPFRE AM, and what is your specific role there?
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Juan Nozal: I joined the management team at MAPFRE AM five years ago, specifically in the fixed income area, where I’m responsible for managing investments for the life and non-life insurance portfolios. Our area performs a wide range of tasks. For example, we’re responsible for aligning investments with the company’s liabilities, and for managing the company’s own funds. We’re also in charge of proposing new investment ideas for the wider network.”
However, my specific role on the team is focused on a two-fold (and complementary) function of analyst-manager within the credit market (corporate bonds). On one hand, I’m responsible for analyzing the solvencies and credit profiles of the various issuers, with the aim of evaluating and developing new investment opportunities. Each person on our team is specialized in one particular asset class for the various types of fixed-income securities, and there is then a more detailed breakdown, into particular industries or geographic regions. For example, I’m responsible for the healthcare, technology, and real estate sectors, among others. On the other hand, we’re responsible for monitoring and tracking performance of the portfolios, and for making active management decisions based on multiple variables. These may be variables that affect the markets (monetary policy, interest rates, macro indicators, etc.), or they may be variables that reflect the needs of the Group’s various companies.
What can we expect from fixed income in 2024?
Well, in order to explain the context of the current market and our vision for the current year, we have to begin by taking a look back. Less than two years ago we were living in a world of much lower interest rates, where fixed-income securities were not a very attractive type of asset for investment. In many cases yields were negative, so investment became concentrated in equities, because although they have a higher risk component, they were offering better returns. In other words, investing in fixed-income securities wasn’t seen as a way to increase portfolio value, but instead, they were treated as a safe haven asset, to provide protection in the context of concerns about a weakening economy.”
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By GlobalDataHowever, during the last few years we’ve had to confront numerous challenges, such as the coronavirus pandemic, supply chain interruptions, and production bottlenecks. Then the war between Russia and Ukraine broke out, which in turn led to an energy crisis. All of those challenges ushered in an inflationary period, which in turn has caused the central banks to tighten their monetary policy in an unprecedented way. All of this has had a strong impact on fixed income.
At this point in time, our belief is that fixed-income assets represent an outstanding option, as a way of coping with inflation without having to take on especially high levels of risk. Just a few years ago, anyone who wanted to use fixed-income securities for investment really had to rely upon high-risk corporate bonds, but now, attractive yields can be found without so much risk. For example, Spanish 10-year sovereign bonds have been offering yields of more than 4% (now 3.2%), with their Italian equivalent up near 5%, and with the German Bund at 3%. And in a situation of inverted curves, shorter terms have paid even more.”
What should we be keeping our eye on this year if we want to understand the evolution of this asset class?
Well, the decisions of the central banks with regard to their official interest rates are obviously worth watching, along with the messages they’re transmitting at their meetings. Many analysts are expecting 2024 to represent a change of cycle. The central banks are sending clear messages that we’re coming to the end of a cycle of tighter monetary policy, but the actual timing of any changes remains unclear, as does the magnitude of any rate cuts they might decide to make. What seems more important to me is the total amount of those rate cuts, rather than when they might begin.
The macro data are also becoming more important, with more influence on the markets. One way of describing this is to say that the financial markets are increasingly data dependent, and on some occasions, they are reacting in an exaggerated way when economic data are released. Ultimately, we need to know how to take advantage of all that volatility.
The upcoming elections are going to be another factor to watch. More than 70 countries will be going to the polls this year, and during election years we tend to see more volatility. The American elections, which will probably be the most closely watched as well as the most influential, will take place on November 5th this year. And in addition to their political results, national elections can also increase social tensions or even aggravate geopolitical conflicts with neighbouring countries.
Finally, during 2024 public treasuries as well as corporations are likely to have especially intensive needs for financing. And this is where investors may be able to buy at a premium based on the curves existing on the secondary market. Even though we’re only one month into this new year, we’ve already seen high levels of issuing by governments. One especially relevant example has been Spain’s historically large issuance (€15bn) of 10-year syndicated bonds, which were also purchased at record numbers. Another example was seen in Italy, which issued bonds in various tranches (7-year, 15-year, and a 30-year tap).
What are your recommendations with regard to different risk profiles?
For conservative investors, we’re recommending an especially high proportion of sovereign debt from more developed (semi-core) countries such as Belgium, and in terms of private fixed income, we’re suggesting high-quality (single A) corporate bonds. As far as terms, I would focus on shorter one to three year tranches, which in view of the inverted curves, continue to offer very good yields, sometimes more than 3%, and this is in spite of the rally we’ve seen recently by bonds with even shorter terms. In terms of industries, I would prioritize the most defensive, such as healthcare, consumer retail, and telecom. These are all industries with stable revenues and the ability to set prices, which gives them more consistent profit levels during difficult times.
For investors with a moderate risk profile, I would focus on peripheral countries such as Spain and Portugal, or even Italy, which not only offer higher yields, but which are also experiencing better growth compared to other eurozone economies like those of France and Germany. We’re also focusing on investment-grade (IG) bonds, which tend to be better protected against scenarios of economic deceleration compared to high-yield (HY) bonds. We’re taking tactical positions in more cyclical sectors, which often do better under circumstances of spread compression. We also think that if interest rates go down, this could generate opportunities in other sectors such as technology and real estate.
Finally, for the most risk-tolerant investors, we would include a portion of high-quality HY bonds with an average rating of BB or BB+. However, we would also select those companies very carefully. And in terms of asset types, we would tend to favor financial subordinated debt.
If we look specifically at investment-grade bonds in euros, what do you see as the best-case scenario for that segment?
In terms of the performance of companies issuing investment-grade bonds, one of the best-case scenarios would be a soft landing for the economy, which is in fact what I think we’re going to see. This can even mean slow growth, as long as it’s sufficient to allow corporate profits to increase at the same pace. It also means that inflation will continue to be reined in, to allow for looser monetary policy. In turn, those lower interest rates will help drive the flow of capital towards private fixed income.
In general, the companies selected should have solid fundamentals, with good net leveraging levels, in a scenario where many companies are able to benefit from the lower financing costs that were available prior to the recent interest rate hikes.
In terms of IG bonds in euros, the spreads are no longer what they were just a few months ago (in some cases it’s even debatable whether they may be underpriced), but their overall yields remain attractive, and their coupon accrual is very interesting too. However, in spite of those appealing valuations, not everything is a good option. This is why we prefer to focus on IG and companies characterized by healthy balance sheets, primarily organic growth, and cash flows sufficient to manage complex situations.
Although the outlook for fixed-income securities seems generally positive, what are some of the risks we should also be considering?
Well, one risk would be that a significant drop in economic activity could occur and lead to a recession. If that occurs, sovereign bonds tend to perform well because of their more defensive nature, while private bonds often perform more poorly, because corporate profits may decrease, along with spreads.”
In contrast, unexpected economic growth can make central banks uncertain about whether to relax their monetary policy, while also creating a risk of renewed inflation. Finally, a rise in geopolitical conflicts can also present a risk. Although it might seem counterintuitive, sovereign bonds may also produce better results during periods of geopolitical risk, compared to corporate bonds. However, any of those scenarios would have a very negative impact on worldwide financial markets, by increasing volatility, risk premiums, and prices for petroleum and other raw materials, which could in turn affect growth.
