Murfin (MFS IM): 'Cash is back but won't beat bonds in 2023'

"Dispersion is back," warns the company's institutional portfolio manager, leading the charge for a return to active management. Emerging debt and European investment grade the main opportunities for this year, “waiting for the central banks' pivot point to return to government bonds”

by Davide Mosca

"After an extraordinarily negative year for the asset class, the starting point for valuations is excellent and, moreover, the decorrelation with equity is set to return. It is also true that with rising interest rates, cash has become attractive again, but in our forecasts the worst-case scenario is that there will be a convergence of returns between bonds and cash at the end of the year. The moment is an important one for active fixed income managers who are looking to 2023 as an opportunity to return to performance.

"Dispersion is back," warns Owen Murfin, institutional portfolio manager at MFS IM, who, from the height of more than 25 years of experience in the bond world, is not intimidated by a situation he describes as "unprecedented".

The month of January was surprisingly positive, particularly considering the many questions still surrounding global growth. How should this figure be interpreted?

There is no doubt that inflation is slowing down but one thing is to go from almost 10 per cent to 6 per cent and quite another to think that we can see a drop to 2 per cent. Unfortunately, inflationary dynamics are more widespread and pervasive than the market believes. Looking at the US we see the cost of services very high and the cost of goods held up by rising energy prices. Rents and airline tickets show a similar trend and investors should not consider these phenomena as being at an end.

The pivot point will therefore not arrive so quickly and does the start of the decrease in rates is more likely to be a mirage derived from the hopes of the markets than a concrete possibility?

At its last meeting, the ECB confirmed a rate hike of 50 basis points for March. The subsequent rally in the markets showed that investors' understanding was that Frankfurt would consider the possibility of cutting the cost of money after March, a possibility that was in no way anticipated by European policy makers. MFS IM's overall strategy at the moment is to be very cautious about any forecasts on central bank behaviour and its impact on future bond prices. It is never a good idea to try to forecast the decisions of the Fed and the ECB because the only ones who may know what they are going to do are the policymakers themselves, since even they may not have extreme visibility if the choice is to use economic data to decide what action to take. And now is a period when there are a multitude of data available, not always consistent with each other.

A topic that is perhaps underestimated by the markets is liquidity. Are there risks on the horizon?

The tightening was strong and happened in a very short time. Obviously, liquidity problems arise with a certain delay as they become fully visible when companies or countries need to refinance accrued bonds. This is even more complicated when central banks are no longer available as potential buyers. On the positive side, however, most companies have entered the rate hike cycle with very strong balance sheets. This does not mean that there are no dangers. We have already seen how the liquidity squeeze has caused big problems in the cryptocurrency world, for example, or with the LDI crisis in the UK. Where I expect the most pressure, however, is in the private debt universe, a sector on which there is far too much consensus. Last year the decline was very mild, less than two percentage points, and in addition the issuers are often small and more exposed to the consequences of recessionary dynamics in the economy.

Given all these uncertainties, what can be said about the outlook for fixed income?

The bond asset class has a real explosion in yields as the carry is joined by a rally in government bonds, a factor that may be caused by a change in the direction of monetary policies, which, however, seems far from certain given the current circumstances.

Does this assumption also include Italian government debt? How do you stand on this?

At this stage we are not positive on Italian government bonds. We have had various positions, even significant ones, in the past but now following the rally and in a context where the European Central Bank is reducing its balance sheet we prefer not to expose ourselves. Furthermore, the new government has still to be tested in terms of its relationship with Brussels and fiscal policies.

What are the most important positions you currently have in your Global Opportunistic Bond Fund? In particular, an exposure of more than 20% to emerging market debt is outstanding.

What we should first note is that a great dispersion in returns within the various fixed income sub-funds has come back. This is good news for active asset managers able to generating alpha. A comprehensive analysis of spreads shows that emerging debt in hard currency is now at one of the best entry points in the last 10 years. This is similar to the situation in European investment grade credit, which is present both in our Global Opportunistic Bond Fund but especially in the Euro Credit Fund where the extraordinary attractiveness at the beginning of the year led us to allocate over 65% of assets.

Our exposure to emerging markets is indeed distinctive in comparison to the benchmark and to our competitors in general. We hold long positions in both local and hard currencies. A point in favour of the sub-fund is certainly the valuations and also that it is not a crowded trade, especially after the large outflows of 2022. China's reopening and the extraordinary strength of the dollar so far, which will not last at these levels, make us look forward to 2023 in the segment with great confidence.