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The renewed supply-driven rise in oil price shows that the risk of inflation rising once more is currently the biggest risk to markets, according to Boutaina Deixonne head of euro investment grade and high yield at AXA Investment Managers.
Speaking to ETF Stream, Deixonne said there could be some “negative surprises” on the horizon that will directly impact future central bank policy. Higher-for-longer rates should not be ignored by market participants.
Despite, this there are still potential opportunities in both investment grade and high yield although investors, notably in short-duration strategies.
Elsewhere, ESG considerations are playing an increasingly important role in investors’ portfolios, according to Deixonne, while using active ETFs to “fill the gaps” in standard indices and generate alpha is proving popular.
What is your current market outlook?
Last year was a very tough 12 months for fixed income markets globally. Equity markets are used to a high level of volatility but to see returns of -10% in fixed income and credit is quite unusual. Since then, market volatility has eased but remains elevated due to uncertainty around central bank decisions.
On the other hand, we are not certain inflation volatility has eased: while we anticipate inflation to decrease in the future, the unpredictability of oil and energy prices could bring unexpected setbacks. This is the main market risk that can influence central bank decisions. On recession, our base case scenario is that momentum is decelerating but we are not entering a tough or deep recession.
How does this impact credit markets at the moment?
Credit now offers an attractive return of nearly 5% for a duration of below 5 years, which has not been the case for over the last decade in the euro market. In the past, some companies issued bonds at 0%, now on average we have coupons at around 4% in investment grade segment and 6-7% in high yield.
When looking at the investment grade space, we are looking for companies with good EBITDA, good visibility on cash flow generation, satisfactory leverage and liquidity, which is what we see today. On the technical front, there is a lot of demand given attractive yields and we expect this may continue for the next 12 months.
Are there any opportunities in high yield?
What we are seeing in high yield is quite different from investment grade. High yield has performed extremely well in 2023 because of the macro background which has behaved better than expected at the beginning of the year.
Unfortunately, flows have not been the main driver of performance, rather it was the lack of supply which supported the asset class. Clients are starting to question the impact of higher default rates and the impact of growth on those companies that are smaller and have less room to manoeuvre. Even though default rates have risen, they remain under historical averages, but we anticipate further increases.
We believe, there may be an opportunity in short duration high yield strategies which has been a success story so far. We are also seeing strong demand for fixed maturity products where investors have been pouring a lot of money this year.
What role do ETFs play in your fixed income portfolio?
Flows in ETFs have been significant in 2023, particularly in credit over the past five months. For the first time, 50% of the inflows in the ETF industry are coming from fixed income exposures. Some investors are still not aware they can access such fixed income exposures through an ETF wrapper. For example, institutional investors are used to dealing with direct lines and mutual funds. At AXA IM, our active ETF offering is quite different from the passive ETFs available in the market. Being active, we can select sectors we think will outperform, instead of merely replicating the index.
What ESG considerations do you consider in your portfolio?
We incorporate ESG principles across our mutual fund and ETF products by applying AXA IM Sectorial and AXA IM ESG Standard policies: they represent normative screens such as UNGC violators and sector screens such as controversial weapons and tobacco. For our Euro Credit PAB strategy we have chosen to go beyond by selecting a Paris-Aligned Benchmark (PAB). The main objective of this index is to reduce the carbon intensity by 7% annually and to achieve alignment with the 1.5°C goal of the Paris Agreement. As such, the PAB approach excludes fossil-fuel intensive companies amongst other screens.
Besides, our credit analysts cover the entire investment universe, looking at financial risk but also risk management discipline. They meet with a lot of the companies we invest in and have regular discussions to understand their business strategy and to assess their ESG risk.
Are passive ETFs limited in their ESG capabilities?
There is broad recognition of a limitation or lack of data for certain indices that exist. I would not oppose active and passive in ETF format but active is complimentary. For example, our Euro Credit PAB strategy is the best of both worlds, using PAB with the improvements of the intellectual capital of an asset management company to fill up the gaps from standard indices and generate alpha.
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To access the full magazine, click here.
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