AXA Sterling Credit Short Duration Bond Fund: Party not over for sterling short-dated bonds
- 06 February 2023 (5 min read)
Key points:
- Sterling short-dated credit bonds are an attractive alternative to cash for investors seeking above-inflation returns
- Yields remain elevated and valuations cheap compared to historical averages
- Rising recession risk and a downward inflation trend could trigger a less hawkish tone from the Bank of England than anticipated.
After a brutal 2022, we believe that short-dated sterling credit could be looking at a year of excellent returns. In fairness, it’s a story that you’re likely to hear about a lot of asset classes right now, particularly in fixed income where valuations look attractive.
But sterling short-dated bonds find themselves in a very particular sweet spot. High yields provide an attractive jumping in point and the current economic climate could provide the impetus for above-inflation returns in 2023.
Bond market recovery offers opportunities
We believe that short-dated bonds are currently in a good position to outperform cash and provide above-inflation returns with a moderately higher risk profile, by benefitting from a strong ‘pull-to-par’ effect, high yields and attractive valuations.
The first month of 2023 has seen markets recovering from the shocks of the year gone by. Lower gilt yields and tighter credit spreads have helped short-dated sterling credit to perform well, with the AXA Sterling Credit Short Duration Bond Fund up by +2.2%1 in January (Z (G) GBP share class, net of fees).
The recovery has been good news for investors who added to allocations in the last months of the year, but we believe the recovery has some way to go. By historical standards, yields remain high, and valuations look attractive.
Source: AXA IM, Bloomberg as at 31/01/2023.
The fall in bond prices has created a powerful ‘pull-to-par’ effect for bond investors. The average cash price of bonds held in our fund is 95.9, a level never seen since its inception in 2010. You would have to go back to the sub-prime crisis in 2008 on the short-dated sterling corporate index to see such a low level. As bonds mature at par (100), we believe that the capital appreciation of bonds could be one of the primary drivers for return in 2023. Furthermore, the income yield of the portfolio should gradually increase over the course of 2023 as we keep on participating in new issues offering very attractive coupons.
Source: AXA IM as at 31/01/2023. Fund average cash price is calculated using weighted average price of bonds in the fund excluding cash and derivatives. For illustrative purposes only. Past performance is not an indicator of future returns
Moreover, UK investors are not rewarded for increasing the duration of their portfolios due to a very flat gilt yield curve. It is also interesting to see that the sterling credit curve is inverted, meaning that valuations are more attractive at the front-end of the curve.
Source: AXA IM, Bloomberg as at 31/01/2023
Economic backdrop supports positive outlook
We see a positive outlook for sterling short-dated credit. Inflationary pressures are widely expected to ease and stabilise in the UK over the year. If the UK tips into a recession later in the year, then the combined effect is likely to see the Bank of England row back on interest rates, providing an uplift for sterling short-dated credit, as the yield curve would ‘bull steepen’, meaning that short-dated yields would fall by more than longer-dated ones.
Active allocations to reflect our views
The AXA Sterling Credit Short Duration Bond Fund was resilient in 2022, outperforming its short-dated peers[1] and short-dated sterling corporate index by +2.2%2 and +3.8%3 respectively.
The outperformance was driven by our structurally conservative positioning and active management. Following the massive repricing in 2022, we gradually re-risked our portfolio to benefit from higher yields and wider credit spreads, switching our sovereign exposure into BBB-rated debt, and increasing the duration from 1.6yrs to 2.4yrs (the highest since its inception in 2010).
Considering the year ahead, we expect markets to remain volatile due to continued inflationary pressures, hawkish central banks and a high risk of recession in UK notably. Nevertheless, we remain optimistic over the medium-term and believe that despite the recent rally in January, there is still ample room to benefit from attractive levels of yields and valuations.
The AXA Sterling Credit Short Duration Bond Fund has a long-standing track record and has benefited from a constant and robust investment process since its inception in 2010. With a 5.1% yield and an average rating of A-, we believe that the fund represents a good alternative to cash for investors seeking above-inflation returns.
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Long-term performance
Source: AXA IM as at 31/12/2022. Performance is presented net of ongoing charges (41 basis points) and gross of tax, and is calculated using mid prices for the Z (G) Acc share class (income reinvested) since its launch in November 2010. Past performance is not a guide to future performance and please note this is not an absolute return or cash plus strategy. *Cash is proxied by a composite of SONIA Compounded Index (SONCINDX) since 29/07/2021 and the ICE BofAML British Pound 3-Month Deposit Bid Rate Average Index (L5BP) from November 2010 to 29/07/2021. Return may increase or decrease as a result of currency fluctuations.
Cash deposits are guaranteed while all investments involve risks. Investments can go up or down and you may not get back the original amount invested. Past performance is not a reliable indicator of future results.
Additional risks associated with this fund include:
Counterparty Risk: failure by any counterparty to a transaction (e.g. derivatives) with the Fund to meet its obligations may adversely affect the value of the Fund. The Fund may receive assets from the counterparty to protect against any such adverse effect but there is a risk that the value of such assets at the time of the failure would be insufficient to cover the loss to the Fund.
Derivatives: derivatives can be more volatile than the underlying asset and may result in greater fluctuations to the Fund's value. In the case of derivatives not traded on an exchange they may be subject to additional counterparty and liquidity risk.
Interest Rate Risk: fluctuations in interest rates will change the value of bonds, impacting the value of the Fund. Generally, when interest rates rise, the value of the bonds fall and vice versa. The valuation of bonds will also change according to market perceptions of future movements in interest rates.
Liquidity Risk: some investments may trade infrequently and in small volumes. As a result the Fund manager may not be able to sell at a preferred time or volume or at a price close to the last quoted valuation. The Fund manager may be forced to sell a number of such investments as a result of a large redemption of shares in the Fund. Depending on market conditions, this could lead to a significant drop in the Fund's value and in extreme circumstances lead the Fund to be unable to meet its redemptions.
Credit Risk: the risk that an issuer of bonds will default on its obligations to pay income or repay capital, resulting in a decrease in Fund value. The value of a bond (and, subsequently, the Fund) is also affected by changes in market perceptions of the risk of future default. Investment grade issuers are regarded as less likely to default than issuers of high yield bonds.
Further explanation of the risks associated with an investment in this Fund can be found in the prospectus.
Short Duration Bonds
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The aim of the Fund is to provide income combined with any capital growth.
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The AXA Sterling Credit Short Duration Bond Fund is a sub-fund of AXA IM Fixed Income Investment Strategies which is a Luxembourg UCITS IV Fund (“fonds commun de placement”) approved by the CSSF and managed by AXA Funds Management, a société anonyme organized under the laws of Luxembourg with the Luxembourg Register Number B 32 223RC, and whose registered office is located at 49, Avenue J.F. Kennedy L-1885 Luxembourg.
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The value of investments, and the income from them, can fall as well as rise and investors may not get back the amount originally invested.