Market review
Global fixed income markets generated negative total returns during the first quarter (Q1) of 2024, as measured by the Bloomberg Global Aggregate Index. Stronger-than-expected economic data and persistent inflation pressures pushed out the expected timing of rate cuts from the U.S. Federal Reserve (the Fed). Resilient consumer spending and strong corporate earnings led to further spread-tightening across many fixed income sectors. Most currencies depreciated versus the U.S. dollar (US$).
Economic data was broadly mixed. While Europe’s economy experienced weakness, the U.S. economy generally exceeded expectations. Inflation continued to moderate across most regions but continued to exceed central bank targets. U.S. labour markets were strong as payrolls continued to gain and jobless claims remained low. U.K.’s economy fell into recession as high borrowing costs discouraged consumer spending. Japan averted recession as initially reported economic data in Q4, 2023 was revised upward, thanks to stronger business spending. China’s manufacturing data got a boost from higher exports but the real estate sector still faces challenges.
Performance review
As of the end of Q1, Sun Life Wellington Opportunistic Fixed Income Private Pool series F (the “Fund”) generated -1.3%. The blended benchmark for the Fund posted a three-month return of -0.1% over the same period.
Performance highlights
At the portfolio level, duration and currency drove negative total returns in Q1 as yields climbed and the US$ strengthened. Credit exposure was additive within sectors such as bank loans, structured products, convertible bonds, and global high-yield.
Strategic sector positions detracted from performance, as positive contributions from bank loans, structured credits, and convertible bonds were offset by negative contributions from nominal and inflation-linked bonds and emerging markets (EM) debt. The portfolio’s exposure to EM and high-quality sovereign bonds came under pressure as markets repriced expectations for the number of interest rate cuts from the Fed. While EM local debt was one of the best performing sectors in 2023, it has struggled so far this year, despite a generally positive risk-on tone within markets.
Relative value positions were flat in Q1. Short exposure to the US$ negatively impacted performance as it appreciated versus most major currencies. Tactical trading amidst modest spread volatility within investment grade at the beginning and end of January helped drive positive total returns within Global Credit Absolute Return during the period. The Absolute Return Mortgages and Discretionary Macro Rates strategies also contributed positively to performance. Our sub-advisor Wellington Management Canada (Wellington) continues to believe this is a fertile environment to add alpha through relative value strategies.
Tactical strategies detracted over the quarter, driven by negative contribution from U.S. agency mortgage exposure. While the rates sell-off was a headwind to performance, the security selection and active trading of the coupon stack added eight (basis points) bps to performance.
Positioning and outlook
Wellington believes alpha will be made by identifying cyclical inflation points faster than central banks and the market. With the market fully embracing a goldilocks scenario, the sub-advisor believes we are at one of those inflection points and have positioned the portfolio accordingly. Wellington maintains an elevated level of duration in the portfolio and is positioned with the lowest level of aggregate credit risk since the Fund’s inception.
Wellington remains committed to some of the ongoing key themes, which include the following:
- It continues to think that in an environment of slower growth and stickier inflation, inflation-linked bonds offer better relative value than nominal bonds. Wellington feels real rates are too high, and that they can go down given slowing global growth. The portfolio has roughly a 23% allocation to inflation-linked bonds through its activist government theme.
- The sub-advisor continues to own EM local debt as part of the portfolio’s EM opportunities theme within strategic sectors. The investment thesis for this theme is that after the pandemic, a majority of EM central banks acted in a highly orthodox manner, pre-emptively raising interest rates well ahead of the Fed, effectively controlling inflation in their countries. As a result, most EM countries have currently started their easing cycles. Wellington continues to like Latin American local currency bonds, which still offer historically attractive nominal and real yields. The monetary easing cycle should allow the region’s central banks to gradually reduce policy rates, which will be a tailwind for local assets. Over the past year, EM opportunities added over 200 bps to total return in the portfolio.
- Currently, the portfolio owns higher coupon to-be-announced (TBA) mortgage-backed securities, because of their attractive carry, relative yield advantage over investment grade corporates, and cheaper valuations.
- Wellington maintains short exposure to investment grade corporates, EM external debt, and high-yield credit where valuations are far too tight as outlined earlier. Wellington continues to find interesting opportunities across structured credit, convertible bonds, bank loans, and capital securities.
