Buy quality bonds

Concerns about higher inflation weighed on returns last year, but as inflation fears recede and growth fears rise, we expect high grade (government), investment grade, and sustainable bonds to deliver good returns over the balance of the year.

We recommend investors approach bonds selectively and actively. We prefer higher-quality, resilient credit given the potential growth risks ahead. We also think there are opportunities to generate alpha through more active duration management in light of the volatile interest rate environment.

We maintain a preference for senior bonds of major banks with solid financial positions, as they remain well protected by ample amounts of loss-absorbing capital. We think that larger, well-capitalized banks should be in a good position to withstand the current uncertainty and market fragility, especially those that have strong balance sheets, stable well-diversified deposit bases, and healthy credit metrics.

Among the riskier classes of bonds, we like emerging market sovereign bonds. Hopes and fears about Fed policy, moves in the US dollar, and the ebbs and flows of risk aversion have left the asset class broadly range-bound this year. Looking ahead, we see supportive factors outweighing the negatives. Improving growth prospects in China should keep credit spreads relatively contained. We also expect the US dollar to weaken and see Fed policy reaching a peak in the coming months. In this context, we see total yields of 8.64% in the EMBIG Diversified sovereign index as representing good value for investors.

We see opportunities to boost returns even further with an active investment approach. In emerging market bonds, the proportion of the sovereign index trading at spreads above 600 basis points remains high, suggesting a broader-than-usual opportunity set among the higher-yielding issuers. In this category, we find value in select issuers that are willing and able to work with international lenders and in select potential restructuring scenarios.