By Flora McFarlane.
With the Fed expected to announce a third interest rate hike in December, and European counterparts likely to follow suit, investors have to consider strategies in a market where interest rate rises can make for a challenging environment.
NN Investment Partners (NN IP) has suggested three potential responses to a moderate interest-rate rise: corporate high yield bonds, emerging market debt (EMD) and alternative credit which would provide returns under two economic scenarios.
Scenario 1 is based on global growth breaking beyond the 3.5% level that has acted as a ceiling since 2011, which Willem Verhagen, senior economist in macro and strategy at NN IP, said would lead to interest rate hikes; positive in an environment of fast growth. However this scenario can only happen if productivity growth moves sustainably higher.
Scenario 2 would be the continuation of rangebound, moderate growth based on a persistent low-risk appetite and lower supply. This is dependent on the rate of inflation growth, with an acceleration of inflation negatively impacting risky assets, however under moderate above-target inflation, risk assets could perform better, according to NN IP’s Verhagen.
Against the backdrop of European high-yield issuance looking set to break the 2015 66 billion euros-equivalent, already having reached 64 billion euros-equivalent this year, according to Bloomberg data, NN IP backs high yield to provide results for investors. The Dutch asset manager favours corporate high yield given the attraction of equity-like assets in a higher global growth environment thanks to its positive correlation to equities among the fixed income classes.
Pieter Jansen, senior strategist in multi asset, also expressed optimism for EMD in both scenarios, with the latter providing favourable conditions in particular.
“It should do particularly well, due to investors seeking yield, their attractive valuations and the moderate US Treasury yield increases that could be expected.”
Alternative credit is seen as attractive to investors in various market conditions, according to NN IP’s report, and a key factor when determining strategies is whether coupons are fixed or floating.
For loan strategies with a floating rate, a rise in interest rates in both of NN IP’s scenarios could prove beneficial. Export credit agency, commercial real estate and EM credit would perform particularly well under the first scenario of higher growth.
Despite a challenging rising yield environment, the analysis affirmed the importance of fixed income, highlighting the opportunities outside ‘the traditional world of ‘safe’ long-duration assets’. Rising government bond yields may not negatively impact all fixed income, however Jansen advised that investors must remain proactive.
“They need to become more selective and find flexible solutions using asset classes that are less sensitive to duration and have adequate growth potential.”