In absolute and real terms, returns for global fixed-income assets have been terrible over the last decade. This unfortunate dynamic has been a direct consequence of monetary policy globally. By anchoring rates at the zero bound, the Federal Reserve capped returns at close to zero for cash investors, resulting in negative real returns. Investors who ventured into other fixed-income assets, such as treasuries and corporate bonds, managed slightly better returns for some years. These investors, however, experienced catastrophic losses when the Fed switched tack and raised rates aggressively in response to higher inflation. Compared to history, real returns for US cash and global bonds have been as bad, if not worse, than those experienced during the inflationary period of the 1970s (see charts below).
Chart 1: Three-year rolling real returns (USD)
Source: Iress, Northstar AM (31 August 2023)
Chart 2: Global bonds three-year real returns (USD)
Source: Iress, Northstar AM (31 August 2023)
Fixed Income assets are offering value, as real yields turn positive
The good news is that valuations have improved as yields have risen along with moderating inflation, providing conservative investors an attractive entry into the fixed-income market.
In response to elevated inflation and a strong economy, the Federal Reserve has been able to raise rates by 5.25% without growth grinding to a halt. The Fed funds rate has taken eleven steps to rise from 0.25% to 5.5%, with the US 10-year bond yield climbing from its lows of 0.32% to 4.33%. In contrast, inflation has moderated from 9.1% to 3.7% and is on track to reach 2.5% within a year.
As a result of the restrictive monetary policy position, the economy will likely slow, allowing the Fed to cut rates by 2% over three years. This outcome will be a tailwind for cash and bond investors, with returns between 4.3% and 5.7%, relative to average inflation of 3.1% (see table below).
Table 1. Bull, bear and base case returns for cash and US treasuries
Source: Capital IQ, Bloomberg, Northstar AM (19 September 2023)
Selective value on offer in other asset classes
Other income-producing assets, such as corporate bonds, inflation-linked bonds, and equities, reflect different levels of value. However, identifying value in these assets requires deeper scrutiny at a sector, company, issuer, seniority or maturity level. For example, credit spreads are generally very compressed, resulting in a high potential for capital losses in the event of any distress or liquidity event in the market. Within credit, short-term spreads on Financials are markedly positive, whereas spreads on IT companies are profoundly negative. Short-term TIPS (inflation-protected treasuries) have recently spiked, reflecting great value in the event of inflation averaging above 2% over the next couple of years.
Of increasing interest are strong dividend-paying stocks like British American Tobacco, 3M, Goldman Sachs, Medtronic, and United Parcel Service etc, which are trading on an average dividend yield of 4.5% and growing their dividends at 5%. Typically, these companies have strong balance sheets, steady revenue growth, stable margins, and excellent cash flow, ideal for navigating more challenging economic conditions.
Northstar launches a Northstar Global Income Fund (USD)
Given the higher yields and the economic conditions described above, Northstar is excited to announce that we recently launched the Northstar Global Income Fund, a perfect investment for low-risk clients looking for hard currency (USD) income. Since launch, the fund has been performing well versus peers and is trading on a yield of 4.65% with a duration of 0.2 years. The long-term aim is to deliver a real return of 2% while maintaining high capital stability.