RW: Our broad strategy has remained relatively constant and we continue to believe in the long-term role that bonds can play in pensions.
We did feel that low yields in 2020-21 did not reflect the rising risk of a period of higher inflation, and this led us to hold an underweight compared to our fund benchmarks.
We have progressively reduced the size of this underweight position over 2022 as valuations have improved. That said, we remain positioned slightly underweight to bonds, reflecting the elevated inflationary backdrop and slightly restrained yield levels.
FTA: Where do you think the fixed income market is heading in the next six to 12 months and what does this mean for pension portfolios?
RW: We still believe that this is a challenging environment for fixed income, against the backdrop of high inflation and sharply rising interest rates in many developed markets. That is why our portfolios still hold a small underweight position.
However, our outlook is much less negative than at the start of the year. With central banks clearly taking actions to control high inflation, and markets consequently discounting further rises in interest rates, there are now realistic scenarios that would benefit government bonds.
These include unexpected falls in economic growth and/or inflation. As a result, we believe that the risk/reward from bond markets has improved and we have increased our exposure.
FTA: What might a recession mean for fixed income in pensions?
RW: In such a scenario, bonds would likely be an important defensive asset for pension investors. However, this is one of many potential outcomes at an unusually uncertain juncture.
The interaction between fast interest rate rises, slowing economies and high inflation clearly creates risks, and bonds are one way to address some of these risks in a diversified portfolio.
However, growth is slowing from a high level, and with most developed markets continuing to see low unemployment and relatively high nominal wage growth, a recession is as yet not a certain outcome.
FTA: Does any particular type of fixed income product stand out for you currently?
RW: We believe that gaining exposure to US government bonds has some attraction within multi-asset portfolios.
They appear to have priced in a continued aggressive approach to interest rates from the US Federal Reserve and are understandably discounting a more inflationary environment than that which has prevailed since 2008.
As a result, US Treasuries now look better priced as a natural hedge for riskier assets in a portfolio and may benefit if either the previous structural headwinds to inflation reassert themselves, or tighter policy leads to a sharp economic downturn.
