Fidelity Short Dated Corporate Bond portfolio managers Kris Atkinson and Shamil Gohil share their outlook for 2025 and provide an insight into how they are looking to position the portfolio against an evolving macro backdrop.
What is your outlook for your asset class?
The UK rates story in 2024 has been one of volatility, rising yields and gradual curve dis-inversion. In 2025 we expect rates volatility to continue, with curve steepening led by front end yields trending downwards as inflation continues to ease and longer end gilt yields under upwards pressure as markets turn their focus to fiscal concerns.
We believe this backdrop will be broadly supportive for short dated Sterling credit in particular. With front end rates falling, investors who have allocated heavily to cash products such as money market funds and high interest savings accounts will be looking to maintain the levels of income they have become accustomed to. This income seeking ‘cash on the sidelines’ will therefore likely be drawn to short dated credit in order to pick up additional yield over falling cash rates in exchange for taking on a bit more risk, whilst still remaining sheltered from significant credit risk against a potentially deteriorating credit fundamental backdrop.
A strong demand for yield has already driven credit spreads in many markets to valuation levels not seen in decades, however our quantitative tools show short dated Sterling credit to be one of the remaining pockets of value. In spread terms, since 2006 Sterling IG has only traded tighter 9% of the time. However, 1-3 year and 3-5 year Sterling IG spreads have been tighter 26% and 16% of the time, respectively. This highlights the relative cheapness and attractive spread cushion still available in the front-end of the Sterling IG curve. To put this into a global context, short dated (1-5 year) US IG spreads have traded tighter only 4% of the time since 2006.
Although upside inflation surprises or an external shock to credit spreads could be risk factors in 2025, we believe short dated Sterling credit where valuations are less stretched and wipeout yields remain attractive will provide ample buffer from negative surprises.
How are you looking to position your portfolio against this backdrop?
Whilst our outlook for the asset class is broadly positive, we are entering 2025 with a backdrop set for continued uncertainty and volatility. In this light, we prefer to be nimble and defensive with our positioning. On the credit front we continue to search for up-in-quality trades, with spread compression between the BBB and A ratings bands meaning we can reduce overall credit risk without sacrificing much in the way of yield, with the strategy still currently achieving an excess yield over the index. Additionally, we are maintaining overweight positions in defensive sectors such as Utilities and Secured bonds, in the latter we are seeing that valuations have not compressed to the same extent as similar unsecured bonds, meaning yields remain attractive on a relative basis with the additional protection of security over underlying assets.
Our defensive bias is also reflected in our underweights, focused on cyclical sectors such as Consumer Retail and particularly the Autos sector, which face headwinds from potential US tariffs and China related factors. We are also maintaining our long-standing underweight to Quasi-Sovereign and Supranational issuers, given the yields on offer here are not as attractive as similar investment grade corporate bonds. Although we are underweight to Banks, we have been looking to increasingly rotate out of subordinated paper into senior paper, increasing the credit quality within this sector underweight, given it is still around 24% of the strategy. Overall, our defensive credit positioning here aims to minimize the impact to the strategy of any risk-off shocks to spreads, given stretched valuations going into 2025, whilst also maintaining yield levels through targeted risk reduction. This defensive base should additionally leave the strategy well positioned to take advantage of market dislocations in the event of volatility, enabling us to tactically adjust credit risk in specific sectors and names at more attractive valuations.
Given the short dated nature of the asset class interest rate positioning tends to play a modest role in risk allocation but we do take active positions when appropriate. Heading into 2025, we are overweight UK gilt duration by around half a year, given an overall view that yields across the Gilt curve fall in 2025. We also maintain a small short duration position in Japan, of around a fifth of a year, given our view that the Bank of Japan continues to tighten monetary policy in 2025.
In summary, we are positioning the strategy with a continued focus on maintaining an attractive yield with a defensive bias as we enter an uncertain year, where the advantages of active over passive management will, in our view, continue to be indispensable in navigating and taking advantage of market volatility in short dated Sterling credit.
IMPORTANT INFORMATION
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates rise and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Fidelity’s range of fixed income funds can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document (Key Information Document for Investment Trusts), current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. FIPM: 8,673
Comments