In this article our Head of Fixed Income, Alex Perowne, shares his thoughts on the effect of rising interest rates on the bond market and the key sectors benefiting as a result.
The move in interest rates over the past 18 months has, on reflection, been fairly extraordinary. Having been stuck at near to 0% (or even negative in the case of both Europe and Switzerland) for much of the past 15 years, Central Banks have now aggressively tightened to 5.50% in the US, 5.25% in the UK, 4% in Europe and 1.75% in Switzerland.
This is creating attractive opportunities for corporate bonds especially, where investors can now lock in high single digit/ low double digit returns, which is close to the highest levels we have seen since 2007.
Bonds are offering the kind of returns that, historically, you would typically expect from equities. There is also the added advantage that, as an investor, you know the yield at the time of purchase and then accrue the coupons on a daily basis, which helps smooth returns and provides regular income to either reinvest or use for expenses. Our clients today benefit from portfolios yielding up to 10% in USD with an average coupon of around 7%* (so offering them both income and capital gains).
Within the current market, investment strategies focused on higher coupon bonds, within mostly defensive and cash generative sectors are likely to have the most favorable returns.
We have identified 4 sectors that we think stand out:
Banking
We like both the senior and subordinated bonds of large cap global banks. Despite the headlines surrounding certain banks this year (mostly Silicon Valley Bank and Credit Suisse), most large cap banks are now highly profitable (as they benefit from higher interest rates and the consequent higher Net Interest Margin they earn), and are well capitalised having spent the last decade building up their capital ratios.
Insurance
Insurers are also benefitting from a higher rate environment as crucially they are now earning an attractive low risk investment return on the upfront premium they receive. Insurance rates have also significantly hardened over the past year – as noticed by many consumers from increases in car and home insurance renewal quotes this year.
Energy
We see energy bonds as being undervalued as energy prices seem well supported and companies are focused on using Free Cash Flow to repay debt, and pay dividends to shareholders. As a result, net debt ratios have meaningfully improved over the past 2 years, with some companies reaching below 1x, and forecast to fall even further in some cases.
Utilities
We believe core utilities are absolutely systemic to European countries particularly in this time of energy scarcity. Often these companies have government stakes or even in the case of EDF, who is 100% owned by the French state.
With the interest rate hiking cycle now close to or even at its peak, we believe now is a good time for investors interested in bonds to lock in these higher returns.
If you would like to find out more about the bond market or how you can take advantage of the current climate, please get touch with info@bedrockgroup.ch.
Author: Alex Perowne, Head of Fixed Income
* Past performance is no guide to or guarantee of future performance
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