Though bond market conditions are favourable, offering good yield opportunities, tight credit spreads compared to historical averages underscore the need for strategic risk budgeting and meticulous credit selection.
Moreover, economic uncertainty emphasises the importance of maintaining tactical flexibility in portfolio construction to adjust exposures as market dynamics change. While most inflation components are slowing down, tariff changes are making the road bumpy. Holding diversified good-quality bonds in these times may help provide a steady core in uncertain times. Inflation kept in check would support bond markets by keeping interest rates stable, preserving real yields and reducing the risk of bond value erosion.
The flip side to this scenario is a potential boom in economic growth. If nominal GDP growth climbed into the high single digits, accompanied by elevated or even accelerating inflation, the Fed would be forced to re-evaluate its policy stance. This would likely lead to rising interest rates and increased bond market volatility.
Uncovering optimal opportunities through active risk budgeting
Active managers – particularly those like PGIM Fixed Income, with global reach and deep credit research capabilities – are uniquely positioned to navigate the complexities of the fixed income markets and uncover optimal opportunities across the spectrum.
We leverage the expertise of 130 portfolio managers and manage over $850bn in fixed income, including over $250bn1 in multi-sector fixed income strategies globally.
Central to our investment approach is active risk budgeting. Our risk budget is being deployed more conservatively at present, with only about 30% currently utilised. This defensive positioning gives us the flexibility to deploy capital and increase risk exposures when spreads begin to widen.
As part of the process of allocating risk effectively, we use a proprietary quantitative tool to evaluate the risk and reward profiles of different sectors and subsectors. This tool analyses maturity buckets, credit ratings, and sector correlations to suggest optimal sector allocations.
Equally vital is rigorous credit research. Our team of 150 credit analysts tracks more than 3,000 issuers globally, providing deep insights that help portfolio managers to identify the best opportunities in fixed income at any point in time.
Finally, while sector allocation and security selection are the primary drivers of performance at PGIM Fixed Income, macro positioning and duration management remain key considerations in our overall investment approach.
Generating multi-sector alpha through security selection
Our extensive experience and rigorous research suggest that certain sectors are currently more attractive than others – for example, we see value in senior tranches of securitised products, which can serve as the defensive portion of a multi-sector portfolio.
Even within these sectors, while average spreads may appear somewhat compressed, we see significant dispersion that presents opportunities to generate alpha through our proven bottom-up security selection process. By focusing on the underlying fundamentals of individual securities, we can identify opportunities that may not be immediately apparent in broader sector-wide trends.
Given the current market conditions, we think shorter-duration bonds (particularly in the one- to five-year range) currently represent a sweet-spot in fixed income. However, we also recognise the benefits of a barbell approach, which combines short- and long-duration strategies to mitigate risk and smooth the sequence of returns.
By balancing the stability of shorter-duration bonds with the higher potential returns of longer-duration bonds, investors can create a resilient portfolio that is less sensitive to interest rate fluctuations. This strategic combination allows investors to achieve a more stable return profile in an environment where interest rates remain uncertain and potentially volatile.
While yields are attractive across the curve, we are cautious about extending duration. There is a fair amount of uncertainty related to fiscal deficits, and for now we prefer to steer away from long-dated, 30-years in favour of short to intermediate-term bonds.
In a dynamic market, staying nimble and adaptable will be key to capitalising on the best opportunities and managing the risks that may arise.
1 Source: PGIM Fixed Income. Assets as at 30 September 2024.
References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in the portfolio at the time of publication and, if such securities are held, no representation is being made that such securities will continue to be held.
The views expressed herein are those of PGIM investment professionals at the time the comments were made, may not be reflective of their current opinions, and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither PFI, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.
Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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