As we negotiate an uncertain landscape, our fixed income teams reflect on potential sources of resilience.
Read this article to understand:
- Why policy flexibility is key in emerging markets
- How we are gauging the resilience of sovereign bonds and ABS
- Strategies to navigate corporate insolvencies in high yield
Welcome to the February edition of Bond Voyage. A key theme this month is that uncertainty seems pervasive right now, politically and economically.
The recent announcement of tariffs and countermeasures by a variety of countries has exacerbated the uncertainty. It will be interesting to see how the situation develops.
In this ever-shifting landscape, our fixed income teams have been thinking about the factors that can help portfolios be more resilient, from policy flexibility in emerging markets to making asset backed securities (ABS) a core part of fixed income allocations.
Feedback is important to us, so please send any thoughts on what you like, don’t like and suggestions on what we might cover in future blogs to: gcs.creditinvestmentspecialists@avivainvestors.com.
Emerging market debt: The politics of economics
In 2025, we are placing particular emphasis on countries at greater risk of material fiscal widening and on those with limited capacity to consolidate but who are promising austerity. This month we examine why some countries may find it politically harder to consolidate. We also look at Asia, a region particularly exposed to the “Triple T” of President Trump, tariffs, and trade.
We examine why some countries may find it politically harder to consolidate
With the focus on fiscal policy in 2025 and the increasingly close link between fiscal policy and politics, we have started to look at why some governments may be voted out and why many are increasingly finding it too politically difficult to consolidate.
Populations have been punishing governments for volatile growth, particularly in incomes. The victory of Javier Milei in Argentina in late 2023 is the most extreme example of this. Zambia and Ghana, with incumbents regularly punished for poor economic performance, are less dramatic but equally relevant instances.
Unsurprisingly, governments that are finding it harder to consolidate through active fiscal policy are those whose populations deem them to be ineffective, particularly where government capacity is eroding. Governments like those in South Africa or Brazil, where social spending is high but effectiveness is deemed to be weak and deteriorating, are particularly fragile politically (see Figure 1).
Figure 1: Bang for your buck – government effectiveness over social spending, 2019-2023
Source: Aviva Investors, IMF, World Bank. Data as of December 2024.
Asia remains one of the most exposed regions to the Triple T
Overall, high tariffs could reduce regional growth by about 1.2 per cent. The impact of these factors varies across countries, depending on their level of exposure to global supply chains. Countries with policy flexibility should also perform better.
Asian countries with low real interest rate buffers could face competitive devaluation by neighbours
A critical challenge for Asian economies is that countries with low real interest rate buffers could face competitive devaluation by neighbours, especially if the Chinese yuan depreciates. India, Thailand, and Malaysia would have some leeway to sacrifice FX stability for growth, while Taiwan and the Philippines have less room for manoeuvre.
Politics will also be crucial for the region in 2025, as several countries are facing challenges and possible changes in government, which come at a delicate time amid President Trump's trade policy uncertainties.
Sovereigns: Gauging bond return resilience
We have been analysing the effects of central bank rate cuts on bond returns. As investors continue to evaluate their asset allocation for the year, it is crucial to consider the potential returns on developed market sovereign bonds.
The starting point for all expected returns is simply the current yield
The starting point for all expected returns is simply the current yield. In Figure 2, we present the current ten-year bond yields for G10 countries (as of January 30, 2025), and their expected return to December 31, 2025 (starting January 30, 2025, assuming no cost of financing) if current yields remain unchanged.
Of course, yields do change. In a typical year, US treasury yields can fluctuate by 100 to 200 basis points (bps), with the 2020-24 average move around 150 bps.
Fortunately for bond investors, income acts as a buffer in the event of higher bond yields. Also in Figure 2, we show the sensitivity of bond returns to 100-bp shocks. Bond returns have some resilience to higher yields and, if yields decline, investors can expect an equity-like return. The skew of returns between the lower-yield and higher-yield scenarios is attractive.
Figure 2: The impact of a 100-bp shock on ten-year bond returns
| Ten-year yield | 2025 expected return (ER) | ER (per cent) if yields +100bp [a] | ER (per cent) if yields -100bp [b] | Skew [b]/[a] | |
|---|---|---|---|---|---|
| US | 4.51 | 4.2 | -2.8 | 11.7 | 4.2 |
| UK | 4.55 | 4.2 | -2.6 | 11.6 | 4.4 |
| Eurozone | 2.5 | 2.3 | -5.4 | 10.7 | 2.0 |
| Japan | 1.21 | 1.1 | -6.4 | 9.9 | 1.6 |
| Canada | 3.14 | 2.9 | -4.4 | 10.9 | 2.5 |
| Australia | 4.38 | 4 | -3.2 | 11.9 | 3.7 |
| New Zealand | 4.48 | 4.1 | -2.5 | 11.3 | 4.5 |
| Sweden | 2.28 | 2.1 | -5.7 | 10.7 | 1.9 |
| Norway | 3.79 | 3.5 | -3.1 | 10.6 | 3.4 |
| Switzerland | 0.42 | 0.4 | -8.5 | 10.2 | 1.2 |
Past performance is not an indicator of future returns.
Source: Aviva Investors. Data as of January 30, 2025.
As bond investors, we like to position for trades where we are compensated for a range of outcomes, with time on our side for our thesis to play out. As easing cycles come to a natural conclusion in 2025, income, carry and rolldown will become increasingly important components of expected returns.
Asset-Backed Securities: Time for a rethink?
After several years of persistent yield compression in the corporate space, and relatively benign credit conditions, we have seen a resurgence of interest in ABS. This culminated in record issuance in 2024 of €134 billion, with growing interest from institutional investors and transactions coming from a greater number of issuers, according to S&P.1
We have seen a resurgence of interest in ABS
As one of a handful of asset managers to have invested in the market since inception, we believe this is part of a meaningful revival for the sector. We are seeing an increasing number of reasons why investors are allocating to ABS as a key constituent of fixed income portfolios.
- Yield premium and relative price stability over government and corporate bonds. ABS offer a “complexity” premium over corporate and municipal bonds, which is likely to diminish over time as demand for the asset class grows (see Figure 3). ABS have also been less sensitive to short-term news around sponsors because of “bankruptcy remoteness” and other structural features meaning they can survive and prosper even if the sponsor defaults.
Figure 3: ABS, corporate and bank spread levels (basis points)
Source: Aviva Investors. Data as of January 24, 2025.
- ABS are becoming more liquid, and concerns that had kept some investors on the sidelines have been largely dismissed.2
- ABS performance has been resilient in recent years. Overall ratings have improved, and defaults are exceptionally low, the lifetime default rate since 2007-2008 averaging 0.2 per cent.3 Confidence has also grown as previous misconceptions about the sector have been addressed and better understood.
- ABS benefit from a multitude of structural protections not offered by corporate bonds, such as: bankruptcy remoteness, high levels of collateralisation, excess spread, and diversity of obligors. Thanks to tougher regulation, deals are underpinned by tighter underwriting standards, greater transparency and enhanced governance.
- ABS have shown low correlation to other fixed income asset classes and lower levels of volatility in both price and ratings. This adds meaningful diversification to portfolios without incremental risk.
- Positive correlation to key macroeconomic variables. We have seen continued robust performance from the most established flow sectors, supported by a healthy labour market as well as tighter underwriting.
- Lower interest rate risk and higher returns during higher rate environments. With most ABS in Europe being floating rate, and their pricing therefore not falling in a higher rate environment, ABS enable investors to lock in a more certain return in an uncertain and “higher for longer” rate environment like the present.
For more detail on economic forecasts see our House View: 2025 Outlook.4
High yield: A modern approach to navigating the high-stakes world of corporate insolvency
Recent restructurings have upended traditional notions of structural, legal, and temporal seniority. This increased complexity brings about greater uncertainty but also presents attractive risk-adjusted investment opportunities for those who can navigate these turbulent waters effectively.
Recent restructurings have upended traditional notions of structural, legal, and temporal seniority
Take, for example, the case of Altice France/SFR. Here, senior secured creditors entered into a cooperation agreement that excluded cross holders whose holdings were skewed to the unsecured notes. The rationale was that senior secured noteholders were concerned about the potential conflicts of interest that would inevitably arise with cross holders. The crux of the issue was legal seniority. Conversely, in the case of Intrum, creditors of equal standing formed separate groups, with holders of short-dated bonds aiming to preserve temporal seniority, and the remaining creditors aiming to bring their own claims to the front of the maturity wall.
Adapting to proactive liability management transactions
So, how should investors be adapting to the increasing use of proactive Liability Management Transactions by European corporates? Here are some of our key strategies:
- Pushing back on weak documentation. Scrutinise documentation in primary markets to ensure it is robust and protective of creditor interests. Whether it is limiting a borrower’s ability to take assets out of the restricted group, or the ability to incur incremental debt, a lot of pain can be avoided further down the road with a little discipline.
- Focusing on credit selection. Aim to avoid weak investments by steering clear of underperformers.
- Exiting underperforming situations quickly. Swiftly exit positions where companies are underperforming and have the potential to carry out coercive actions against creditors.
- Understanding conflicts at underwriting. At the time of underwriting new investments, thoroughly assess potential conflicts of interest and their impacts.
- Monitoring conflicts of interest. Vigilance in monitoring potential conflicts of interest within is essential to stay ahead of adverse developments.
- Demanding high margins of safety. In stressed situations, demand a sufficiently high margin of safety to ensure an attractive probability-weighted return. Participate only when the price offers a substantial margin of safety.
The evolving landscape of corporate insolvency both in Europe and the US requires a dynamic and proactive approach. By leveraging game theory, maintaining rigorous credit analysis, and staying vigilant about potential conflicts, we can navigate these challenges and uncover valuable investment opportunities.
