In recent years, historically low interest rates have resulted in investors being hesitant towards investing in fixed income strategies. However, rising global rates, currently in a range consistent with higher inflation and real rate expectations, may well warrant a change in attitude, according to Richard Piccirillo, managing director and senior portfolio manager for PGIM Fixed Income.
And with data from the middle of 2022 pointing towards declining inflation and the increased probability of a “soft landing” in the US, as well as widening spreads compared to the middle of 2021, investment attitude is more optimistic.
For Piccirillo, what appeals to investors in terms of seeking absolute return fixed income strategies is a dynamism with respect to duration and credit risk exposure, with greater risk latitude than a typically actively managed fixed income portfolio.
“This appeals to investors, because at a time of recent volatility, they don’t necessarily want to take on market beta risk. They’re looking to be more opportunistic and are not looking to simply gain the credit risk in a benchmark. While they’re still thinking about the recent history of the markets, they recognise the risks and many are looking towards a strategy with some duration,” he observes.
Risk control and diversification
Piccirillo says controlling risk is as imperative as it is universal across all PGIM’s portfolios. In terms of seeking absolute return, it's a strategy that seeks to modulate risk according to market conditions without an expectation to maintain a certain level of risk exposure.
“We’re looking to scale investment opportunities according to our conviction within preset risk parameters and our global macro outlook. As a large asset manager, we are able to utilise our resources in multi-sector portfolios to optimise value and risk across the broadest set of fixed income market opportunities,” he explains.
Opportunities and outlook
Lower inflation in the US and post-Covid recovery in China are, according to Piccirillo, good examples of growth drivers on the horizon. And while there may still be some volatility to overcome in the short term, these are good signs that better growth may finally be on the horizon.
“Volatility has created opportunities for high quality as well as low quality assets, although within a cautious framework, with companies and countries having to raise money at valuations sufficient to attract capital,” he says. “Our outlook is changing as the data comes in, but last year, given the recent persistent threat of inflation, tightening financial conditions and hawkish central banks, recessionary expectations were quite high.”
However, he admits that the market is now seeing a fairly consistent string of lower inflation numbers in the US, which has been reflected in market spreads. Globally too there is an expectation that central banks will not have to be quite as hawkish as they were perceived to have been two months ago.
Asia Pacific markets
Piccirillo notes that the firm’s absolute return strategies have always had exposure to non-US countries, and that generally speaking, this has been through US dollar-based portfolios with global exposure.
“We do feel that Asia Pacific will be benefiting a lot from these dynamics and the expectations of an easing of policy in respect of the opening of China that has caused distress in the near term but looks to create a better environment in the immediate and long term,” he says. “There are also emerging-market countries where the debt dynamics are likely to lead to better growth opportunities, either in a country, or quasi or corporate basis. One example is Indonesia, a country where we’ve been overweight for some time, and which has shown fairly consistent growth.”
He says PGIM tends not to have extreme duration or currency exposure, and that despite having been overweight in duration for some time, this changed in the middle of 2022.
He also notes that the firm’s exposure to macro global variables has been less than its competitors. Here he points to a more diversified bottom-up sector strategy with industry, issue or country exposure with a mix of assets that have fundamental or relative value that is expected to outperform competing investments.
“One of the main reasons why absolute return strategies are becoming more attractive again is an expectation that interest rates would rise with inflation, resulting in the desire for a portfolio with less duration. Investors are also looking for flexibility around credit risk and opportunities. They also realise there are risks on the horizon and they remain cautious,” he says.
“Ultimately, we have the resources that allow us to provide flexible solutions and a menu of alpha seeking opportunities where clients can tailor their portfolios to their own asset mix, based on their own constraints, and set a risk budget based on their own investment objectives.”