Forty-nine percent of fixed income investors globally expect the economic cycle to continue for one or two more years, while 27% see it ending within the next six months to one year, according to a recent survey from Invesco.
The study involved face-to-face interviews this year with 145 chief investment officers and fixed income asset owners across North America, Asia/Pacific and Europe/Middle East/Africa responsible for the fixed income components of portfolios totaling $14.1 trillion in assets under management as of June 30.
“Investors believe we are quite late in the current economic cycle, but we found they are not foreseeing a significant correction in fixed income, and rather expect the rare event of a soft landing with a continued flat yield curve,” Robert Waldner, chief strategist and global head of multi-sector portfolio management at Invesco Fixed Income, said in a statement.
(Last week, the yield curve between 3-month and 10-year Treasuries inverted for the first time since 2007.)
With the current economic expansion running for nearly a decade, the most common view of investors is that it still has legs, but some are nervous about how long it can go on and are alert for triggers that could end it.
Survey respondents’ expectations on the cycle’s duration differed significantly between regions. Fifty-two percent of North American investors saw it ending in the next 12 months, while 75% of Asian investors expected the cycle to continue for a year or more.
What did investors think could trigger a downturn? Their main concern was high levels of government debt, though they also worried about several sources for potential disruption emanating from the global backdrop, including trade wars.
Most investors, however, expected the economic cycle to end in a soft landing, with a correction in the equity markets more likely than a significant sell-off in bonds. Against this backdrop, 60% of investors said credit spreads would widen over the next three years, and 45% said the yield curve would remain flat for a prolonged period.
“Growth risks are skewed to the downside, but our clients seem fairly confident that the next recession won’t be nearly as bad as the last,” Waldner said. “Because of this view, they’ve invested in higher quality bonds and scaled back risk, but they are also looking for the slowdown to reset asset prices that may have been artificially inflated by central banks.”
As well, he said, they will likely take that opportunity to add at higher yields.
Invesco’s survey found that Chinese fixed income allocations were set to grow as investors look through trade and geopolitical issues in their search for enhanced yield and diversification.
Many investors recognize that China is underrepresented in bond portfolios, especially given its role in the global economy and the size of its debt market. Thirty-two percent of fixed income investors globally said they would increase their allocations to China over the next three years.
U.S. investors are currently less likely to hold Chinese assets in their fixed income portfolio, according to Invesco, but 58% said they would increase allocations despite rising trade tensions.
Invesco said that for half of global investors, this is a longer-term strategic decision that will be reinforced by the increased weighting of China in major fixed income indexes expected in 2019 and beyond.
Up to now, engagement levels have been low, and barriers persist in the form of access limitations, local currency risks, the threat of government intervention and limited transparency, according to Invesco. However, with the prospect of higher yields and lower correlations to developed markets, combined with higher weights in fixed income indexes over time, there should be a structural tailwind for investing in China.
“There is a growing fascination with China as an investment destination, given its sheer size and economic heft, but also given its rapid market liberalization and growing list of highly successful corporations,” Julie Salsbery, Invesco’s director of business strategy, said in the statement.
“While index inclusion will definitely accelerate both awareness and investment, China is still classified as an emerging market and will therefore likely be subject to bouts of volatility.”
Mainstreaming of ESG Fixed Income
Environmental, social and governance investing is moving from a niche investment approach of a minority of asset owners to becoming part of mainstream fixed income investment processes, according to Invesco. The primary drivers are perceived benefits to risk management, the potential for enhanced returns and growing interest from stakeholders.
Even so, significant adoption issues remain. Survey respondents grapple with a lack of reliable data, they find only a limited number of capabilities and products suitable to their needs, and they have varying views on the principles-returns tradeoff, despite research that shows ESG approaches need not compromise returns.
According to the survey, the level of commitment to implementation varies widely, but larger funds are likelier than smaller ones to have made a firm commitment, built specialist ESG teams and engaged directly with companies.
North America’s commitment to ESG is growing but still lags, with 44% of investors having an overall commitment and only 38% considering ESG within their fixed income portfolio.
EMEA countries remain in the vanguard, with 76% of respondents having an overall ESG commitment policy and 51% considering ESG factors within their fixed income portfolio.
“Interest in ESG investing continues to evolve from simple negative screens where portfolios exclude certain industries, to an integration of ESG factors into risk/return analysis for each asset, to positive screening and impact investing,” Salsbery said.
“With few hard-and-fast rules and definitions, and only nascent regulation, ESG investing requires active management and active engagement with each client to ensure their unique objectives are being met.”
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