For a while now, the outlook for investment-grade markets has been directly linked to the outlook for global interest rates and the ongoing debate about how much longer central bank monetary policy will remain tight.
Since the second half of 2023, Aegon Asset Management has held the view that the threat of inflation – especially in the US and Europe – will begin to dissipate and reduce the threat of further rate hikes.
In turn, the manager believes that tangible evidence of a slowdown in continental Europe, and signs that economic activity in the U.S. is starting to turn negative, will remain in place in the early months of 2024, leading major central banks to cut rates over the next 12 months, ultimately propping up investment-grade credit spreads.
Funds Society had a conversation with Euan McNeil and Kenneth Ward, fund managers of the Aegon Investment Grade Global Bond Fund, to discuss the strategy and outlook for the actively managed fund, which was established 16 years ago and actively seeks opportunities in global corporate bond markets.
In the talk, the PMs noted that as cash starts to become a less attractive option as an asset class in this environment, the likely allocation toward investment grade credit should prove to be a very supportive technical driver. They also said that generic valuations (on a yield basis) are as attractive as they have been for several years.
“In this context, our expectation would be that subordinated (and higher yielding) financial paper would likely be the most attractive in such a scenario,” they stressed.
In 2023, the Aegon Investment Grade Global Bond Fund B Inc USD returned nearly 10% net of fees, putting it about 70 bps ahead of its benchmark, the Bloomberg Global Aggregate Corporate.
“We had a strong year,” Euan McNeil, a 20-year industry veteran, begins. “We benefited both from our proactive positioning of credit risk and from having managed interest rate and duration risk very actively throughout the year. This has been another important contributor to the fund’s performance”, he details.
“We were set up for much of the second half of 2023 for the market to start pricing in rate cuts across Europe, the US and UK, reflective of what we believed would be an improving inflation backdrop,” McNeil explains. They positioned the portfolio with a long duration bias and an increased credit overweight. With the first signs of change in central bank rhetoric coming through in October – reflective in part of the tangible deterioration in macroeconomic data and expectations of a dovish response – the fund benefitted from this positioning in the latter part of October and through all of November, with government bond yields falling across the curve and credit spreads tightening. “With the market now moving toward our view, we moderated the duration (and credit) overweight into year end”, he completes.
What are your expectations for asset class performance in 2024?
We would be reasonably comfortable with total return expectations for global investment grade credit in the 6% area, although, as always, nothing moves in a straight line. Given the rally we saw to close out 2023, we believed it was prudent to raise cash slightly with the aim to redeploy it to more attractive levels in the near term and take advantage of the traditional uptick in issuance you see in January. But ultimately, we believe the more subdued central bank outlook, rate cuts and potential slowdown in the economy should underpin spreads and provide a fairly favorable backdrop for the asset class in 2024.
What could be the risks in 2024?
One risk would be that the economic slowdown is greater than expected. There is also the risk that inflation accelerates. In other words, if inflation surprises to the upside and central banks feel they must continue to pursue tight monetary policy, that could pose a threat to risk assets, and credit spreads would be vulnerable in that scenario.
What is the fund’s current positioning?
We have recently undertaken a small reduction in aggregate risk across the portfolio. We are still slightly overweight in risk assets versus the benchmark, but the extent of that has moderated. We still like the financial sector, where we have recently reduced risk, but we have seen some rehabilitation and some recovery in that industry. However, we see the financial sector have strong fundamentals, as long as you can pick the geographic locations, such as Europe and the United States.
And we remain more cautious in sectors such as commodities, where we have seen more mixed results. As of December, the fund had approximately 67% exposure to dollar-denominated investment grade credit with 22% in euros and 10% in sterling.
What are the differentiating factors of the fund’s strategy?
The first is the willingness and ability to manage the top-down credit risk of a portfolio to actively adjust its duration and interest rate. Many investment-grade funds simply operate with a duration-neutral position versus the benchmark; we, on the other hand, take active duration positions, and we also actively manage the overall credit portions of the portfolio. We’ve also built a fund that is a concentrated, high-conviction portfolio with a bottom-up approach. I think that differentiates us from the competition: the concentrated nature of the portfolios we manage.
The Aegon Investment Grade Global Bond Fund aims to provide a combination of capital growth and income. Its fund managers specialize in seeking to add value through security selection driven by solid bottom-up credit research, investing primarily in investment grade government and corporate bonds in any currency, which can be fixed or floating rate, rated or unrated. The fund may also hold selected high yield bonds and cash.
As of December, sector allocation is currently distributed 47% in industrials and 36% in financial institutions, while roughly 8% is positioned in the utilities sector. In terms of credit rating breakdown, 55% is BBB; 30% is A; and 11% is AA. Geographically, almost 49% of the credit is from the United States, while credit from Europe, distributed by country, has a similar proportion.
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