The next downturn will likely be global. Typical cycles live and die by monetary policy; this time, we will be watching global trade.
Investors in short-term debt are at the mercy of low policy rates. They could be sacrificing yield for some time.
We believe the Loomis Sayles Investment Grade Bond Fund’s flexible, research-driven, fundamental approach is well-suited for today’s challenges.
Only we think it doesn’t. Risk-taking doesn’t have to be a binary decision. We agree that more conservative positioning may make sense right now. But uncertainty can create opportunity, as we’ve seen time and time again. The world has changed in important ways, and investors should account for these changes as they look for pockets of value. We think a patient, selective approach can work in this environment.
More than ten years into this expansion, cracks are beginning to appear in the corporate bond market. We are currently in a trade-induced slowdown and we expect credit losses to rise. These cracks have many investors feeling nervous and craving stability. At the same time, the reach for yield is very real. Some investors caught in this tug of war are sitting in short-duration strategies while trying to time the cycle. This approach may involve some unappealing tradeoffs.
In a market prone to volatile swings, it’s tempting to think of short-duration credit as a one-stop shop for stability and yield. But in our view, the short end of the corporate bond curve is often the least attractive in terms of risk-reward potential. Why? It comes down to a fundamental rule of finance: no return comes without risk. Investing in high-quality paper at the front of the curve offers low yields. Reaching for yield could entail unintended or unanticipated credit and liquidity risks. This can be a dangerous prospect when liquidity conditions turn negative.
In this environment, we aim to earn yield through a carefully selected combination of credit and duration risk. When we have fundamental conviction in a name, we generally prefer to push out the curve and seek to capture the credit at a greater discount (see chart below). Parts of the market look fairly priced in our view.
In today’s unprecedented yield environment, we believe investors should consider adjusting their definition of value. Yes, yields close to 3% on US investment grade corporates are low. But compared to Europe, where much of the debt carries negative yields, US rates currently look attractive (see chart below). We also see value in some high yield corporates.
Across the credit spectrum, it’s about being selective at this point in the cycle. We are monitoring corporate health, and we continue to believe geopolitics will be a dominant force driving global markets. We think portfolios need the research backing and flexibility to move quickly when opportunities arise. Fundamental research and portfolio flexibility are at the core of how we manage the Loomis Sayles Investment Grade Bond Fund. Our large staff of analysts tracks global economies and hundreds of individual securities looking for value. This work is central in preparing us to step in and buy when the market appears skittish. We hunt for bonds we think are mispriced, and maintain liquidity in the portfolio for just those situations. We don’t look like a typical core fixed income fund concentrated in government and investment grade securities. In this low-growth, low-yield world, our research-driven, flexible approach allows us to find potential opportunity outside of the core fixed income universe. We are a different bond fund for a different time.
Investing involves risk, including risk of loss. Portfolios that invest in bonds can lose their value as interest rates rise, and an investor can lose principal. Investments in mortgage securities are subject to prepayment risk, which may limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity. Foreign and emerging market securities may be subject to greater political, economic, environmental, credit, currency and information risks. Foreign securities may be subject to higher volatility than US securities due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets. Below investment grade fixed income securities may be subject to greater risks (including the risk of default) than other fixed income securities. Mortgage-related and asset-backed securities are subject to the risks of the mortgages and assets underlying the securities. Other related risks include prepayment risk, which is the risk that the securities may be prepaid, potentially resulting in the reinvestment of the prepaid amounts into securities with lower yields.
Diversification does not ensure a profit or guarantee against a loss.
Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index.
Past performance is no guarantee of future results.
This paper is provided for informational purposes only and should not be construed as investment advice. Opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted, and actual results will be different. Data and analysis does not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice.
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