(Bloomberg) - Vanguard Group Inc. has a message for investors waiting for the all-clear before returning to fixed income following a brutal rout this summer: “Shake it off.”
The world’s second-largest asset manager, overseeing $7.8 trillion globally, expects interest rates to remain higher for longer and projects a shallow recession around mid-2024 and minimal room for high-grade spreads to tighten. Still, the Federal Reserve is nearing the end of its hiking cycle and investors are better off locking in higher rates for longer by loading up on corporate bonds, the firm’s fixed-income team led by Sara Devereux wrote in a note seen by Bloomberg.
“Taylor Swift packed stadiums all summer, and her fans broke the internet trying to get tickets so they could celebrate her Eras Tour,” Devereux and her team wrote. “Fixed income investors also tend to think about eras. We believe we are in a new era for fixed income in which bonds offer significantly more value - both in total returns and as better ballast within an overall portfolio.”
Malvern, Pennsylvania-based Vanguard finds high-quality investment-grade corporate bonds the most attractive in credit right now. For one, many of these companies took advantage of the cheap money era to strengthen their balance sheets before the hiking cycle began.
To be sure, “it was a cruel summer for bond investors,” the analysts wrote. Investment-grade bonds, which typically have higher duration than their junk-rated peers, have been hit hard as the sell-off in Treasuries wreaked havoc across all corners of the credit market. The benchmark high-grade US credit index had the worst quarter since last September — on a total returns basis — and is headed for a third straight monthly loss.
And the outlook for these notes isn’t looking too rosy. The 10-year Treasury yield crossed 5% for the first time in 16 years this week and the Fed is leaving the possibility of a future hike open if policymakers see further signs of resilient economic growth. The higher the duration, the more sensitive the bonds are to central bank actions.
Vanguard, which oversees $2 trillion in fixed-income assets globally, is neutral in its high yield bond exposure and expects capital needs and competitive pressures to put pressure on some sectors, which could bring some unidentified “idiosyncratic opportunities.”
Outside of corporate bonds, the firm is attracted to mortgage-backed securities’ high-quality credit profile, diversification and liquidity. In the municipal bond market, Vanguard favors longer-term investment-grade bonds rated below AAA. Having a long duration bias to hedge credit risk makes sense in most cases, they said.
By Caleb Mutua
