Thoughts for 2025
Perspectives from a leading fixed income specialist
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Video: asset class overview
Jill Hirzel, senior investment specialist provides an overview of the key messages from our Thoughts For 2025 in this video.
We outline our views for the year ahead, covering key fixed income markets, rates, inflation, multi-asset investment and currency. For those seeking to invest responsibly we focus on nature-related risks, including access to water.
Global rates: time for a reality check
Real policy rates have moved from deep negative territory to the highest levels since before the global financial crisis, providing central banks with the flexibility to start easing. Although prudent rate cuts are necessary to underpin growth and ensure a soft landing, the exuberance of rate markets is questionable. Markets are now pricing in a faster easing cycle than previous crises, which seems at odds with an economy that is still growing and an equity market close to record highs.
Global inflation: the best news is behind us
We believe factors such as the shift from globalisation to deglobalisation will keep inflation structurally high in the coming years. In the US, sticky inflation, monitored by the Atlanta Fed, is declining at a slower rate than the headline consumer price index and has stabilised at around 3%. Stickier inflation is just one of the challenges facing central banks, with food prices and money supply turning upwards once again.
Credit: time for active managers to shine
Robust investor demand has compressed spreads to below long-term average levels. Despite this, absolute yields remain high relative to the past decade. This environment presents a unique opportunity for active managers to enhance returns beyond yield alone. High levels of issuance should provide ample opportunities for stock selectors to capitalise on new issue premiums and unique investment stories in 2025.
High yield credit: the power of compounding
High yield credit is particularly suited to compounding returns over time, with market yields high enough to amplify the power of compounding. High yield corporates have weathered the sharp increase in interest rates over recent years, and defaults in the current cycle are at relatively low levels.
Multi-asset: a simple approach is unlikely to work in 2025
Our regime-based framework became more neutral in the summer, and we adjusted our cyclical exposures downwards. However, we are conscious that easier monetary policy should support economic activity, potentially shifting us into a more positive growth regime in 2025. One concern we have is the lofty valuation of US equity markets, as history suggests valuations do matter. This may mean a more targeted approach to risk-asset allocations may be necessary in the year ahead.
Investment grade credit: time for active managers to shine
Robust investor demand has compressed spreads to below long-term average levels. Despite this, absolute yields remain high relative to the past decade. We believe this environment presents the opportunity for active managers to enhance returns.
In a striking contrast with research focused on active equity managers, data from Mercer indicates that median managers in global credit and aggregate strategies have historically outperformed their benchmarks. High levels of issuance should provide ample opportunities for stock selectors to capitalise on new issue premiums and unique investment stories in 2025.
US municipal bonds: prudently enhancing yield
Taxable municipal bonds offer a higher yield compared to US Treasuries and can periodically even offer higher yields than US investment grade corporates.
These issues are backed by tax revenue streams, and generally have a low likelihood of default. In our view this puts taxable municipal bonds in a sweet spot between Treasuries and investment grade credit, offering a prudent way to enhance yields while minimising credit risk.
Secured finance: choose your risks wisely
With central banks easing rates, it may seem counterintuitive to invest in instruments with coupons linked to short-term rates. However, we believe that the high level of spreads offers the potential for still attractive levels of income, especially if easing cycles are shallower than expected. These structurally high spreads are a result of complexity premium, with the potential for illiquidity premium in less liquid assets. Such premia are available despite the fact that these issues are secured and have experienced low levels of defaults historically.
Global currencies: check your hedge
Managing currency risk can reduce the volatility of an international portfolio and improve overall returns. However, currency-hedged share classes are often inefficient. We outline five reasons why we believe investors should rethink the use of hedged share classes – including the potential for significant performance drag over time. We believe a dedicated currency manager can offer transparency and achieve lower transaction costs compared to fund structures.
Access to water: a growing risk
Water risks are material and diverse, with significant implications for corporate bond portfolios. These risks include market-based transition risks, such as tightening regulations and water prices, and physical risks, such as aquifer depletion and degraded water quality.
Global water risks are rising due to demographic growth and climate change, leading to increased agricultural demand, pollution, and groundwater depletion. Insight’s research highlights water risk as the most material source of nature risk to corporate bond holdings.
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