Three charts that show the advantage of an active approach to fixed income

Pendal’s head of income strategies AMY XIE PATRICK argued in favour of an active approach to fixed income at this year’s Lonsec Symposium

• Pendal employs AI to analyse “central bank speak”
• Active management matters the most when markets are volatile
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

I RECENTLY had the pleasure of participating in a fixed income panel at the Lonsec Symposium.

It was the most engaging panel session I’ve attended in a long time – and if nothing else, it tells me that this asset class has become a hot topic.

In case you weren’t able to attend, here’s a summary of my main observations from the Symposium.

1. What’s better than a rate-cutting cycle for bonds?

In 2022, the Pendal Income and Fixed Interest team embarked on an exercise to see how bonds and equities performed in different parts of the rate cycle.

The motivation?

Being in the middle of the steepest hiking cycle I’d ever witnessed in my career. I wanted to see just how ugly it could get for bonds.

To do this, we needed to look at data going back as far as the 1970s and the era of hyperinflation.

The results gave us a surprise beyond our original curiosity.

Of course, bonds do well when central banks are slashing interest rates, but it turns out that what’s even better for bonds is when central banks come to the end of hikes.

Opinions are divided about whether cuts will come this year, how many and how soon. On the margin, some debate whether another one or two hikes might be necessary.

This first chart cuts through all that noise – what it tells us is that as long as the conviction has shifted away from hikes, then good times lie ahead for bonds.

2. So, is this the post-hike pause?

Yes, I think so. But having an objective way to discern how policymakers are leaning is key.

At Pendal, we employ the AI power of large language models to help us decipher “central bank speak” – be it from their statements, minutes or general speeches.

This thinking is not novel, but our methods are unique.

When you do nothing to the raw language coming out of central bankers’ mouths, generative AI tools have a hard time delivering useful results for investors; ten attempts may well lead to ten different answers.

By design, language models prioritise syntax (language) over logic. Our methods look for ways to clean the raw language to make it as straightforward as possible.

The crucial test for whether our measures are useful is the presence of a relationship to local policy rates and yields.

When Pendal’s hawkishness scores peak, policy rates and front-end yields usually peak as well.

What these charts show is that both the RBA and the Federal Reserve have passed their peak hawkishness. Peak policy rates and yields won’t be far away, if not already behind us.

This is most likely the post-hike pause where bonds do their best work.

3. Don’t just close your eyes and buy

Yes, bonds are back. Yes, the time is now. But the road for fixed income has been bumpy.

Active management matters the most when markets are volatile.

As the above chart shows, when volatility spikes, the dispersion between active managers’ performance in fixed income really stretches out.

What you can’t see from the chart is that first-quartile managers during the calmer times are rarely able to keep their positions in more volatile times. This makes sense because you need different active tools in different volatility regimes.

Volatility today is about as low as it has ever been in the last three decades.

Now is the time to ensure that not only is your fixed interest exposure allocated to an active manager, but that the managers you choose have what it takes to weather the next spike in volatility.