(Bloomberg) - For Vanguard’s Sara Devereux, the recent debt rally brought the chance to reduce credit exposure and buy mortgage agency securities based on valuations, setting up what promises to be a bond picker’s paradise in the new year.
“This is not an environment where all boats are going to rise and selection is going to be critical,” Devereux, global head of Vanguard Fixed Income Group, said in an interview on Friday. “We are maintaining dry powder that we can deploy at more attractive levels.”
In its 2023 outlook published on Monday, Vanguard Group Inc. foresees a global recession next year as the Federal Reserve and the world’s central banks keep rates high to bring down inflation. Softer inflation data last month spurred a $2.8 trillion bond-market rally, one that may continue if data this week show consumer-price increases decelerating and the Fed confirms market expectations for a reduced pace of interest-rate hikes.
While 2023 is shaping up to be a good year for fixed income, credit markets are “not out of the woods” yet and Vanguard — the second-largest asset manager with $7.1 trillion under management — expects spreads to widen, though not to extreme levels as defaults will be milder than in past economic downturns, Devereux said.
“Choosing the right names, avoiding the losers, can be just as important as finding the winners in an environment like this,” she said. “Right now it is a terrific environment for that because there’s such a dispersion in valuations and in quality that using that elbow grease and really getting in the weeds and going name by name, we can add a tremendous amount of value.”
Vanguard is loading up on debt from mortgage agencies because spreads have moved to attractive levels, Devereux said. Any decline in volatility in Treasuries as the Fed gets closer to the end of its rate-rise cycle will also boost the debt, she said.
In corporate credit, the asset manager likes debt from companies with higher credit ratings, strong balance sheets and cash flows, and from less cyclical sectors. The firm is leaning more into high-grade debt and higher quality parts of junk and reducing holdings in parts of the markets that outperformed this year, like loans and emerging-market debt.
US corporate investment-grade bonds are on course for their worst year on record. Vanguard expects central banks to remain hawkish in 2023, but a slowdown in the Fed’s pace of increases should support battered corporate bonds.
“Bonds are better,” said Devereux, who heads a team comprising about 180 traders, portfolio managers, research analysts and support staff at Malvern, Pennsylvania-based Vanguard, manager of $1.9 trillion in fixed-income assets. “All-in yields that we’re looking at are better than we’ve seen in a decade. That income is a terrific buffer to any price volatility that we may see.”
By Caleb Mutua
