Falling interest rates mean that older bonds are paying higher interest rates than new bonds, and therefore, older bonds see their prices rise.
Exploiting price inefficiencies
According to a Pimco spokesperson, when recession risks are higher, "you want to be very cautious about credit-sensitive investments", although the spokesperson says current conditions are quite positive.
"The big challenge is that we have an inflation problem, so you have policymakers tightening when growth is already relatively low. Plus, it has been a long time since there has been a recession without massive policy support," the spokesperson adds.
"A lot of people invested heavily in credit-related assets over the last decade because they felt they needed to generate incremental return."
Different durations
Duration is used to estimate how sensitive a particular bond’s price is to interest rate movements.
Pimco's representative says: "While duration is not the same as a bond’s maturity date, it is true that bonds with long maturities are generally more sensitive to interest rate movements, while bonds with shorter maturities are less sensitive.
"This is ultimately because investors in longer-maturity bonds will not be repaid their principal for some time, so they have an increased risk exposure; whereas holders of shorter-maturity bonds will get their principal back sooner so have less long-term risk."
One reason high-yield bonds often have relatively low duration is they are typically issued with terms of 10 years or less and are often callable after four or five years.
Generally, high-yield bond prices are more sensitive to the economic outlook and corporate earnings than day-to-day fluctuations in interest rates.
Value of diversification
Because there are parts of the bond market that are more sensitive to rate movements than others, diversification becomes key.
Bonds with a longer time to maturity are more sensitive to rate rises than short-dated bonds, as the negative impact of the rate rise on the bond coupon has longer to be felt.
Byrnes explains: "A long-term bond may have 30 coupon payments left, which will be negatively impacted by a rate rise, whereas a shorter-term bond may only have a couple of coupon payments left."
But despite the near-term uncertainty in bond markets, managers have said they are finding opportunities in fixed income – not just in investment grade (AAA-BBB rated bonds) but also in higher yield (BBB- and below).
High yield opportunities
Capital Group investment director Flavio Carpenzano says HY bonds have performed better than "most other" areas of the fixed income market during the recent sell-off.
"The shorter duration of the high-yield market means it is less sensitive to the higher interest rates that we are experiencing alongside higher inflation and monetary policy normalisation," he explains.
"The historical correlation of high-yield bonds with interest rates has been relatively low as high yield has tended to be driven more by credit risk than interest rate risk."
