Quick Thoughts: Don’t Miss The Return Opportunity In Fixed Income

Given the current economic backdrop, where can investment opportunities be found, particularly within the fixed income asset class? Head of Franklin Templeton Institute Stephen Dover shares his key takeaways from a panel discussion that he moderated with fixed income experts within the company.

Global capital markets have seen strong performance in 2023 despite the backdrop of economic challenges. What are the investment opportunities going forward? Why is fixed income corporate credit offering particularly attractive opportunities right now? I discussed these issues with a group of fixed income experts within Franklin Templeton. Here are my key takeaways from the discussion:

Move out of cash and into fixed income. While interest rates on cash are high, fixed income instruments provide similar yields with the added benefit of higher future total returns if interest rates decline. Given the current dynamics, the panel thought this was a good time to lock in current interest rates.

Corporate bonds show solid fundamentals. Current leverage, interest coverage, free cash flow and amortization schedules are at stronger levels than in the recent past. Focusing on higher-quality instruments allow portfolios to capitalize on generous current yields, income that could help weather economic storms should the economy weaken further than we expect.

Companies re-financed at low rates during the pandemic, avoiding the need to refinance at today’s higher rates. This may have contributed to the lower impact of the Federal Reserve’s rate hikes as companies do not need to refinance. Many companies may need to refinance by 2025, and thereafter, but we expect rates to decline before then.

High-yield bonds offer attractive total returns and better credit profiles than in the past. High-yield bonds may offer a bridge for investors between the typical risk/return profiles of fixed income and equity, with yields near 8.5% and some capital appreciation potential.¹ In terms of improved quality, the proportion of issuers that are public companies has grown. This is important because they tend to manage their balance sheets more conservatively. In addition, the amount of secured high-yield debt has also risen.²

Private credit offers higher yields and lower correlations. Private credit providing a level of certainty and flexibility that banks can no longer offer has fueled corporate growth. A highly diversified pool of mostly senior secured loans generates strong risk-adjusted returns, with higher interest rates, lower leverage and tighter terms. Yields in private credit range from 11.5% to 12.5%,³ but investors must be able to bear illiquidity.

According to the panelists, interesting industries for opportunities include non-bank financials and select cyclical credit, including chemicals and homebuilders. Sectors to avoid include wireline telecom and mall-based retailers.

In conclusion, fixed income currently looks more attractive based on higher overall yields. Well-chosen, quality fixed income can add value beyond yield generation, benefiting from capital appreciation if there are future rate cuts.

—

Originally Posted August 11, 2023 – Quick Thoughts: Don’t miss the return opportunity in fixed income

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

IMPORTANT LEGAL INFORMATION

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton. 

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal. 

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data.  Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. 

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.  

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

1. Source: Bloomberg, as of August 4, 2023.

2. Source: Bloomberg, “Borrowers Flock to High Yield Bonds, Ditching Leveraged Loans,” August 3, 2023.

3. Source: Bloomberg, “Private Debt Unitranche Loan Index, Yield to Expected 3-Year Takeout,” July 24, 2023.