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Given that some types of securities can be risky, especially if purchased do-it-yourself, in order to diversify the bond portfolio it is necessary to find the right balance both in terms of duration and type of asset (variable rate or fixed rate). Manuel Mendivil, partner of Arcano and Co-CEO and CIO of Arcano Capital Alternative Asset Manager, a management company founded in 2003, explains it in detail.
Following further tensions in the geopolitical framework and a possible instability in raw material prices, is it possible that inflation will rear its head again?
Inflation could surprise on the upside, just as it did at the end of 2021. In Europe we tend to over-translate US data and this time the inflation risk is very different. Looking at the ECB, we believe that the rate cut in June remains the base case, as inflation is expected to continue to fall. The two economies are also diverging: while the US remains strong, we see near-zero growth in Europe this year.
What scenario is emerging in Europe for credit and shares?
The reason why the ECB will probably cut rates before the Fed is that the Eurozone economy is weaker. This is a worse case scenario for stocks more than credit. Last month the PMI index in the US manufacturing sector rose above 50, which indicates the dividing line between expansion and recession. European manufacturing data clearly remains in recessionary territory. When it comes to corporate debt, however, it’s a good time to invest as yields are at all-time highs – even if spreads are not – and rates are likely to be cut in the coming months.
SPREAD AND YIELD TO MATURITY
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And where do high yields fit into this context?
Just as in early 2023, the consensus on the attractiveness of long duration fixed income has proven wrong. The results for the current year show High Yield bonds at +1.5%, Leverage Loans at +2.5%, Ig bonds at -0.5%, with Government bonds further negative depending on the expiration. The opportunity lies in variable rate assets: you get a hedge against the risk of inflation and surprising upward rates, and in the meantime you get a return of 7-8 percent.
Isn’t there a risk of a deterioration in the health of businesses, especially in Europe where the economy is weaker?
Certainly, although this is nothing new. The higher rate environment ushering in 2022 has resulted in a significant increase in sector and market dispersion. This means that you cannot rely on sector dynamics alone. Nowadays and within any industry there are reasonable balance sheets and cash flow producing companies, but there are also over leveraged companies in non-growth markets struggling to repay debt. Portfolio managers who didn’t feel comfortable with a certain bond or loan in 2022, when the market picture was different, had plenty of time to get rid of it.
