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Staying invested with a flexible fixed income approach as inflation bites

PHOTO: J.P. MORGAN ASSET MANAGEMENT

It could likely be another year of negative real cash returns in 2022. For most investors, staying invested and seeking out assets that generate income will be important to ensure their overall portfolio’s purchasing power is not eroded by inflation.

As inflationary pressure is building up in certain markets including Singapore and the United States, several central banks are considering raising rates, albeit gradually. We share our perspectives on how we continue to seek yield opportunities in fixed income with a flexible approach1.

Our current view

The search for yield is intensifying among investors as the Federal Reserve (Fed) has begun pulling back the stimulus provided at the onset of the Covid-19 pandemic. The US central bank is reducing its net asset purchases2 by US$30 billion (S$40.7 billion ) per month as it accelerates its response to rising inflation.

As illustrated in the chart below, US real yields stood at -3.45 per cent while inflation was 4.96 per cent, as at Dec 31, 2021.

Source: US Bureau of Labor Statistics, FactSet, Federal Reserve, J.P. Morgan Asset Management. Real 10-year Treasury yields are calculated as the daily Treasury yield less year-over-year core CPI inflation for that month. For the current month, we use the prior month’s core CPI figures until the latest data is available. Guide to the Markets – U.S. Data are as of Dec 31, 2021.

The more persistent components of inflation, namely wages and housing, are showing signs of an upward momentum that could outlast the near-term inflation in durable goods. Even though the latest Covid-19 variant, Omicron, has raised uncertainties, it is more likely to be a bump in the recovery path instead of one that could derail economic growth.

We believe US monetary policy is shifting towards tightening, and it is important to look at both the timing of the first rate hike, likely in 2022, and the number of hikes in the next few years3.

The Fed will likely hike rates by 25 basis points each quarter until they reach 2.25 per cent to 2.5 per cent in mid-2024. Both the Bank of England and the Bank of Canada are expected to start hiking this year ahead of the Fed, while the European Central Bank has signalled its first rate hike no earlier than 20233.

Navigating the current market environment

We recognise that we are at a major inflection point for central bank policy, growth and inflationary pressures, and the market environment will thus be more volatile and challenging.

Even though persistent inflation and greater possibility of rate hikes are pointing towards rising bond yields, relatively attractive income opportunities can still be found across the global fixed income universe. For example, we believe the fundamentals are improving for US and European investment-grade companies as well as some quality high-yield corporates4.

Against the current market environment, a flexible approach to the bond market is key. This defines our approach for J.P. Morgan’s Income Strategy as we seek to capture income opportunities, alongside diversification across the fixed income investment universe.

  • Seeking attractive income with a prudent level of risk5. We implement our high-conviction income ideas across locations, markets, sectors or ratings. We seek an income profile similar to high-yield4 credit but with lower volatility, and we do so by sourcing income from sectors with low to negative correlations. As illustrated in the following chart, this results in portfolio volatility that is lower than some of the individual sectors such as US high-yield4 and global investment-grade corporates.
Source: Barclays Live, J.P. Morgan Asset Management. MBS refers to mortgage-backed securities, global IG corp bonds refers to global investment-grade corporate bonds and US corp HY refers to US corporate high-yield bonds. Volatility is realised annualised volatility based on monthly data since the inception of J.P. Morgan Income Strategy. Indexes used are: Bloomberg Barclays Treasury Index, Bloomberg Barclays US MBS Index, Bloomberg Barclays Corporate Credit Index and Bloomberg Barclays US HY Index. The Strategy seeks to achieve the stated objectives included in the offering documents. US Corporate High Yield is based on Yield to Worst. US Treasuries, MBS and global IG corporate are based on Yield to Maturity. The Strategy is based on Yield to Maturity of the underlying portfolio. Past performance is not necessarily a reliable indicator for current and future performance. Yield is not guaranteed. Positive yield does not imply positive return. Data as at Nov 30, 2021.
  • Seeking consistent dividends. Given the current market conditions and with some investors focused on income opportunities in their portfolios, our approach is to employ an income filter to select attractive income-generating securities with risk-adjusted yield profiles, focusing on providing consistent income. This proprietary income bank mechanism serves to create a reserve for consistent distributions over time.
  • Active duration6 management when positioning for changes in interest rates. In fixed income investing, duration is a gauge of interest rate risk, showing how bond prices will likely change when interest rates move. As the movement of interest rates can have a significant impact on an income portfolio, managing duration is crucial for both alpha generation and risk management5. For example, a longer duration bond may suffer more price decline in response to a 1 per cent rise in interest rate. Hence, actively managing the duration of the Strategy could help reduce the overall interest rate sensitivity of the portfolio.

Positioning the portfolio1 for a rising rate environment

As we position ourselves for a rising rate environment, and as a part of our overall portfolio allocation, we currently see opportunities1 in:

Conclusion

Even though inflation is high and interest rates are poised to rise, investors can find relatively attractive income opportunities across the global fixed income universe, based on their investment objectives and risk appetite. Our flexible approach in J.P. Morgan’s Income Strategy helps us seek such opportunities amid changing markets.

  • Please click here to find out more about JPMorgan Funds – Income Fund.

Provided for information only based on market conditions as at date of publication, and not to be construed as investment recommendation or advice. Forecasts, projections and other forward-looking statements are based upon current beliefs and expectations, and may or may not come to pass. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecasts, projections or other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.

Yield is not guaranteed. Positive yield does not imply positive return. Diversification does not guarantee investment return and does not eliminate the risk of loss.

1. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.

2. Source: ”Federal Reserve issues FOMC statement”, Board of Governors of the Federal Reserve System, 15.12.2021.

3.  Source: J.P. Morgan Asset Management, “Global Fixed Income Views 1Q 2022”, 13.12.2021.

4. High-yield credit refers to corporate bonds which are given ratings below investment grade and are deemed to have a higher risk of default. Yield is not guaranteed. Positive yield does not imply positive return.

5. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk.

6. Duration is a measure of the sensitivity of the price (the value of the principal) of a fixed income investment to a change in interest rates and is expressed as number of years.

7. Securitisation is the process in which certain types of assets, such as mortgages or other types of loans, are pooled so that they can be repackaged into interest-bearing securities. Examples of securitised debt include ABS and MBS.

This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. It does not constitute investment advice, or an offer to sell, or a solicitation of an offer to buy any security, investment product or service. Informational sources are considered reliable but you should conduct your own verification of information contained herein. Investments involve risks. Investments in funds are not deposits and are not considered as being comparable to deposits. Past performance is not indicative of future performance and investors may not get back the full or any part of the amount invested. Dividend distributions if any are not guaranteed and are made at the manager’s discretion. Fund’s net asset value may likely have high volatility due to its investment policies or portfolio management techniques. The value of the units in the scheme and the income accruing to the units, if any, may fall or rise. Funds which are invested in emerging markets, smaller companies and financial derivative instruments may also involve higher risks and are usually more sensitive to price movements. Any applicable currency hedging process may not give a precise hedge and there is no guarantee that any hedging will be successful. Investors in a currency hedged fund or share class may have exposure to currencies other than the currency of their fund or share class. Investors should make their own investigation or evaluation or seek independent advice prior to making any investment. Please refer to the Singapore Offering Documents (including the risk factors set out therein) and the relevant Product Highlights Sheet for details at https://am.jpmorgan.com/sg/en/asset-management/per/. Issued by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K). All rights reserved.

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