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Insights   •   Fixed Income

Fixed Income CIO Letter

CIO, Global Fixed Income, Currency & Cash

We are now more than one year removed from 2020’s extreme market volatility. And while the pandemic continues to affect our daily lives, volatility has receded and markets have embraced the idea of a continued, strong, global recovery. In this letter, we’d like to update you on the status of our fixed income business in 2021 and highlight some of the most important trends and developments we’re observing in fixed income.

Mid-Year Update for Indexed Fixed Income

Risk control is at the center of our disciplined indexing process, and 99.4% of our indexed fixed income portfolios tracked their benchmarks within prescribed tolerances. We saw substantial inflows to our fixed income strategies in the first half of 2021, and our indexed fixed income assets under management grew by 12%. Net client inflows totaled $36 billion, with the largest component of that in multi-sector index strategies such as the Bloomberg Barclays Aggregate Bond Index ($27 billion). Beyond that, we saw significant ($12.5 billion) inflows to US Treasury and global sovereign portfolios (as investors rebalanced away from strong-performing equity assets) as well as equivalent net inflows to income-oriented strategies ($12.7 billion cumulative net inflows to High Yield, Investment Grade Credit, and Emerging Market Debt). (See Figure 1).

While much of the flows to income strategies was a reflection of investors seeking yield in a generally low-yielding market, we also saw an increase in clients using these high-yielding public fixed income sectors as a tool to equitize cash designated for investment in even higher yielding – and less liquid – allocations in their portfolios, such as private markets. 

Figure 1 1H2021 Indexed Fixed Income Institutional Flows

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Amid strong demand for corporate bonds, spreads tightened further throughout the first half of 2021, reaching multi-decade lows (see Figure 2). Narrower spreads, combined with the continued expansion of electronic trading platforms, have led to a substantial decline in the dispersion of spreads across issuers, sectors, and ratings categories. This continued the trend we saw in the years running up to the pandemic of compressed alpha in fixed income sectors traditionally driven by security selection (such as corporate-related credit). We believe that growth in our index credit strategies is a reflection of this. 

Figure 2 OAS by Quality

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Key Trends and Developments

In an effort to gain deeper insights into investor trends and client needs, we partnered with an external research firm to conduct a survey of over 350 institutional investors across the globe. The survey revealed four key trends:

A clear move to indexing. Over 66% of respondents said the increased use of indexing is a high priority for core fixed income exposures over the next three years, with 63% saying the same for non-core exposures. While active fixed income portfolio management is still seen as valuable by most institutional investors, the gaps between active and index outcomes are narrowing in many sectors of fixed income, especially those sectors traditionally seen as active-only, i.e., High Yield and Emerging Market Debt. Price transparency due to technological advancements has led to more efficient markets, which means alpha sources have become more difficult to find. In contrast, index allocations provide a cost-effective and highly transparent tool to access key exposures and desired yield. As noted earlier, we have seen the trend toward indexed fixed income evidenced within our business.

Increased utilization of ETFs. Over 68% of respondents said ETFs will play a larger role in fixed income portfolio construction, with 71% planning to increase ETF use within core exposures and 48% within non-core exposures. Respondents had a positive view of fixed income ETF performance and the liquidity and flexibility ETFs provided during the 2020 pandemic-related market stress. Ease of use, speed of execution, and lower costs were the top factors driving survey respondents’ plans to increase allocations to fixed income ETFs over the next three years.

Focus on ESG in fixed income. Integrating ESG within fixed income is a high priority over the next three years for a majority of investors in the US and Europe. Though a longstanding key consideration for our European clients, US clients have increasingly placed greater importance on ESG principles within their portfolios. 

China inclusion and emerging markets. Most respondents said they plan to maintain or increase emerging markets exposure overall, a market currently worth over $6 trillion. In addition, 38% of the largest investors surveyed say a dedicated fixed income exposure for China is a high priority over the next three years. 

Conclusion

Though markets have calmed substantially since last year’s crisis, the fixed income market is always changing, and we remain vigilant in monitoring and responding to developments. We will continue to utilize our deep insights into market structure, liquidity, and risk as we partner with clients to achieve their investment goals in indexed fixed income. We thank you for placing your trust in us and look forward to working with you in the second half of 2021 and beyond.

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