Global Credit – 2024 outlook

Fortunately it’s possible to anticipate the future return profile of short-dated global credit with a reasonable degree of confidence. Doing so is certainly less complicated than predicting economic conditions and movements in interest rates and, in turn, forecasting possible returns from aggregate-style fixed income alternatives and other asset classes.

To help explain why that’s the case and what we’re anticipating for the year ahead, it’s worth taking a minute to review the year that’s passed. 
 

Monthly returns from fixed income alternatives, calendar year 2023

Source: Bloomberg

The blue bars show returns of the Bloomberg Global Aggregate Index, hedged into Australian dollar terms to approximate the returns from global bonds for Australian investors. The green bars show returns of the Bloomberg AusBond Composite 0+ Year Index, a commonly-used reference index for traditional Australian fixed income funds investing predominantly in government and government-related securities.

Returns from global and Australian bonds were fairly volatile during the year, owing to fluctuations in interest rates. The Bloomberg Global Aggregate Index generated negative returns in seven of the 11 months up until the end of November, while the Bloomberg AusBond Composite 0+ Year Index fell in five of the 11 months.

Forward-looking expectations for official cash rates moved quite significantly as investors digested the latest economic indicators – particularly inflation data – and tried to predict how the Reserve Bank of Australia and other central banks around the world might react. These evolving expectations resulted in a fair amount of volatility in interest rates.

The duration profiles of the indices contributed meaningfully to the volatility. The duration of the Bloomberg Global Aggregate Index is currently around 6.6 years¹. Other things being equal, this means the Index will rise or fall in value by around 6.6% following a -/+ 1% move in interest rates. Similarly, with a duration of around 5.0 years², we can expect the Bloomberg AusBond Composite 0+ Year Index to appreciate or depreciate by around 5.0% following a -/+ 1% move in interest rates.

Nobody knows for sure how interest rates will move in 2024 and how traditional, aggregate-style fixed income funds might perform as a result. What we do know is that the return volatility during 2023 was unpalatable for investors seeking stability and, ideally, capital preservation from the defensive component of their investment portfolios.

In contrast, our flagship global credit strategy – the First Sentier Global Credit Income Fund – enjoyed a much smoother return profile over the year.
 

Monthly returns from First Sentier Global Credit Income Fund, after fees, calendar year 2023

Source: First Sentier Investors
 

At the time of writing at the end of November, the Fund had generated positive returns in all 11 months of the year, after fees. Based on our conversations, this type of consistency and durability is exactly what risk-averse, income-oriented investors are looking for.

The Fund appreciated even during periods of weaker market sentiment, such as in March and October, for example, when credit spreads widened. This acted as a headwind for performance, but was not sufficient to drag monthly returns into negative territory.

Boosted by higher interest rates globally, the running yield of the portfolio has risen to nearly 6.0%³. Essentially this means the Fund is earning at a run rate of around 0.5% per month. Credit spreads would have to widen quite meaningfully to offset this income and result in negative returns owing to mark-to-market revaluations of the underlying bonds held. This is not impossible, but we are not anticipating a significant deterioration in market conditions or a substantial widening in spreads.

This Fund also has a very short duration profile, which is important to bear in mind. At the time of writing the Fund’s duration was just 0.69 years⁴, meaning the Fund is substantially less sensitive to changes in interest rates than aggregate-style bond funds.

All of this is important, because a combination of relatively low interest rate sensitivity and the receipt of regular income from bond coupon payments suggests short-dated global credit should continue grinding out positive returns in the year ahead. We are reasonably confident that the Fund will continue to generate returns over and above comparable aggregate-style fixed income funds, as well as comfortably beating the returns currently on offer from cash and term deposits.

As a reminder, the First Sentier Global Credit Income Fund aims to return 2% p.a. above cash (represented by the Bloomberg AusBond Bank Bill Index). For some, this kind of return profile may be insufficient to get the pulse racing. But for others a high likelihood of positive returns month in, month out is likely to remain appealing. We have seen good inflows into global credit over the past 12 months and expect to see further interest in 2024. For the reasons outlined above, we believe short-dated global credit products such as the First Sentier Global Credit Income Fund will continue to generate steady positive returns in 2024 and remain appealing for income-oriented investors with a low tolerance for volatility.