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Outlook for 2022: Fixed Income

 In search of interest-bearing alternatives

Government bonds this year were just ballast in investors’ portfolios. Their prospects for 2022 don’t look much better. So, it accordingly remains essential to resort to alternative interest-bearing instruments.

 

Seldom has a reliable performance forecast been so easy to make as the one this year for (investment-grade) government bonds. Since their yields at the start of January were near all-time lows well beneath (Germany, Switzerland) or at least close to the zero line (UK, USA), they really could only climb from there, and bond prices accordingly had to fall. So, it can’t surprise anyone that 10-year benchmark bonds are ending the year with a negative return performance ranging between –2% and –4%. One could admittedly be surprised, though, at their increased correlation to stocks and the resulting erosion of their diversification attributes. In the final analysis, purportedly safe bonds proved to be the only ballast in investment portfolios in 2021. Resorting to emerging-market bonds also didn’t generate any added value. Many central banks in emerging economies already saw themselves compelled this year to raise interest rates (sharply in some cases), which caused bond prices in their countries to fall as well. Whoever wanted to earn money with traditional fixed-income securities therefore either had to move farther up the risk ladder into high-yield bonds or had to rely on inflation-protected bonds. The latter at least lived up to their job title this year and guarded portfolios against the stronger-than-expected inflation. Interest-bearing alternatives such as microfinance bonds and insurance-linked bonds, which we recurrently have advised investors to own, also generated unspectacular but solidly positive returns. However, to earn a decent return with cat bonds, you had to be sufficiently diversified because 2021 turned out to be another year of relatively high natural catastrophe claims losses (due to Hurricane Ida in the USA, for example) and corresponding adverse performance impacts on affected individual cat bonds and cat bond funds.

 

Due to rising yields…
…government bonds were just ballast in 2021

10-year government bond yields

Sources: Bloomberg, Kaiser Partner Privatbank

 

What advice do we have for fixed-income investors for the new year? Our rather uninventive recommendation is to stay inventive. Since our baseline scenario for 2022 sees long-term market interest rates holding steady or continuing to edge up slightly, erstwhile core fixed-income assets threaten to deliver a negative or at best a breakeven return again next year, especially after inflation is deducted. High-yield bonds might again post a slightly positive performance, but their tight credit spreads do not offer a very thick buffer against rising interest rates. Microfinance bonds, in contrast, should once again prove sustainable and solid. Meanwhile, insurance-linked bonds could become even a bit more attractive on the back of upward-drifting insurance premiums (as a result of the past several “challenging” years for the (re)insurance industry). To moderately broaden exposure to interest-bearing alternatives, it’s also worth taking a look at the multifaceted private debt sector, where peer-to-peer lending and credit strategies like real estate bridge financing look interesting to us.

 

Oliver Hackel, CFA Senior Investment Strategist

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