This focuses on opportunities, but there are always risks lurking to snare the unwary. Hedging strategies will remain key: there is no guarantee the shocks of 2022 are fully behind us, and every reason to believe they have heralded an age of persistent instability.
In the first quarter, for example, we saw stress in financials after both Silicon Valley Bank and Credit Suisse collapsed, leading to fears of contagion.
This not only left us more convinced of the likelihood of a recession, which could put some pressure on credit spreads, but also led some managers to adopt a cautious stance with a defensive risk appetite, reducing portfolio risk and cutting higher risk areas of emerging market, high yield and subordinated debt in favour of developed market investment-grade corporates and focusing on issuers whose fundamentals they are more comfortable with.
Prior to the challenges faced in the banking sector in March, it had been a source of debate in our team as to why we had not seen more damage after one of the fastest periods of monetary tightening market participants had ever experienced.
The delayed impact of these policy shifts has finally revealed fragility under the surface, and we believe it is likely that more unexpected pockets of vulnerability will appear.
Potential expansion
Inflation is not yet a big enough political problem that any serious politician would propose cutting spending to stop it, and with both the US and UK starting to think about general elections in 2024, we do not think they have much appetite for inflicting pain on their populations.
This leads us to think leaders will again opt for fiscal expansion, which could create opportunities.
In our view, there will be credits that benefit from a historically rapid reflation, interest rate curves may get steeper, and countries that give money away too enthusiastically to their citizens may face interest rate premia.
Overall, while the recent stress in the banking sector spooked investors in the first quarter, the prompt intervention of central banks maintained financial stability.
While we believe these events brought the risk of recession forward, there are plenty of remaining inflationary forces that are unlikely to go away any time soon.
Therefore, we prefer to hold a moderate exposure to interest rates with four years of duration, as we believe that the path towards lower rates remains uncertain.
In a rapidly changing macro environment, remaining flexible and dynamic is paramount.
However, the strongest conviction we have is that we are at the dawn of a new regime, and that being a successful investor in the next 10 years may require a different set of skills compared to what was required over the past decade.
