The Case for Active Management in Today’s Bond Backdrop

Oct 28, 2024

Gregory Peters, Co-Chief Investment Officer at PGIM Fixed Income, explains how active managers can add value in today’s economic backdrop.

The Global Economy: Perched at a Crossroads

The bond outlook is bright for fixed income investors. After pausing interest rate hikes for more than a year, and after much anticipation, the Federal Reserve lowered interest rates in September for the first time since 2020, beginning an expected period of easing monetary conditions.

PGIM Fixed Income’s base case is for continued global growth over the coming year, primarily driven by additional central bank rate cuts and ongoing fiscal support. While China’s stimulus policy has raised investor interest in emerging markets, this optimism is shadowed by potential risks, such as political upheaval and renewed debt sustainability concerns. These factors contribute to a climate of potential volatility, but one that likely will not derail ongoing economic growth.

Bonds Stabilising After Rollercoaster Ride

The bond market has taken a rollercoaster ride so far in 2024, oscillating between waves of optimism and pessimism in response to fluctuating economic data. Interest rates have followed suit, rising early in the year when inflation remained ‘sticky’ and subsequently declining as inflation began to cool. With yields primarily stabilising, high-quality fixed income returns paused in the first half of the year while higher-yielding sectors continued to post gains, albeit at a slower pace than in 2023.

Looking ahead, fixed income markets appear to be pricing in a period of reasonable certainty and a fairly sanguine risk environment. The backdrop of high and stable long-term interest rates creates fertile ground for fixed income investors. Even with expected rate cuts, long-term yields are likely to remain steady because investors have already priced in several cuts. Heavy government bond issuance also may impede any substantial, sustained decline in long rates.

Gradual normalisation of the U.S. yield curve underway

Today’s Backdrop Favours Bonds Over Stocks

As we transition into a more conventional interest rate environment, current yield levels on fixed income assets have emerged as historically attractive. In a rate-hiking cycle, cash is attractive when stocks fall, but that is not the case in a rate-cutting environment because cash is a depleting asset and likely will underperform if rates hold steady or fall. Furthermore, the defensive qualities of bonds are particularly striking in the current climate. If equity markets correct sharply, bonds can serve as effective portfolio shock absorbers, offering stability through the turmoil.

Meanwhile, relative values have shifted, and bonds are now much less expensive—or ‘cheaper’—than stocks, positioning fixed income for competitive risk-adjusted returns. Although credit markets do not appear cheap from a broad perspective, we see lots of relative value when digging below the surface.

Returns Based on Federal Reserve Regime When Equities Declined by At Least 5%

Actively Seeking Multi-Sector Opportunities

At PGIM Fixed Income, we construct our highly diversified multi-sector bond portfolios with caution, aligning with the current economic landscape. Our strategy is predicated on careful consideration of risk while maintaining a focus on high-quality investments. In the investment-grade sector, we favour structured product securities such as AAA-rated collateralised loan obligations, which provide robust protection and diversification, a nice spread, and minimal real default risk. Additionally, our analysis suggests that certain shorter-term segments in this sector offer yields that make them attractive.

Within our high yield bond exposure, we are concentrating on high-quality structured bonds, given the current unattractive state at the top level of the market. It’s worthwhile to note that dispersion in the high yield market is at a multi-decade high. As an active manager, PGIM Fixed Income sees attractive investment opportunities in this sector, given the wide dispersion.

Through our intense focus on industry and issuer credit research—along with our collaborative, bottom-up, research-driven security selection process—we are able to actively and nimbly extract multiple sources of alpha across spread sectors, industries and issues. In our search for value, we pursue an ‘unconstrained’ fixed income investing strategy that gives us the flexibility to adapt to changing market risks and capitalise on a wide range of opportunities.

A Fixed Income Foundation Built on Experience

With 150 years of experience and 355 investment professionals, PGIM Fixed Income is one of the largest and most-experienced fixed income asset managers globally with $805 billion in assets under management, including $241 billion in multi-sector assets.¹ Our depth of resources differentiates us from our peers. We have assembled a deep bench of portfolio managers, credit research analysts, and quantitative and risk management experts who collaborate as equals to optimise active fixed income solutions for investors. This structure leads to necessary checks and balances among the three key components of investing:

Credit Research: Our robust credit research arm, comprising 146 seasoned analysts averaging 24 years of experience, enables us to evaluate securities meticulously and assign an internal rating for every portfolio holding, which are used to establish relative value rankings within and across sectors.
Portfolio Management: This 131-member team averages 26 years of experience, leveraging PGIM Fixed Income’s scale to provide access to new offerings and enhance its ability to negotiate attractive terms. Managers determine the specific mix of securities and adjust position sizes based on strategy-specific investment guidelines, risk profiles and constraints.
Risk Management: The 78 members of this team, averaging 23 years of experience, establish a risk budget for every strategy, which are used to monitor each portfolio and recommend adjustments to the portfolio managers.

As fixed income markets evolve, it’s critical to understand the global economy, the path of interest rates, and the broad spectrum of bond market sectors. With strategic allocations toward multi-sector bond investments, PGIM Fixed Income is an active manager that can add value in today’s backdrop through strategic positioning, navigating changing macro conditions, and capitalising on bond market dispersion. Explore PGIM Investments’ ‘Fixed Income Hub’ for solutions that can help investors strike the right balance with bonds.

¹PGIM Fixed Income data, as of June 30 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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