Market View I Dickie’s View March 2024

Richard “Dickie” Hodges, Manager of the $2.3bn Nomura Global Dynamic Bond Fund, provides his view of the fixed income market environment:

Published 8th March 2024

Key Takeaways

• By the end of February, some 3 to 4 rate cuts of 25bps were priced-in for 2024. We believe this pricing remains a little too optimistic, and another rate cut can and should be priced out of markets in the near term.
• However, the Fed will likely cut rates later in 2024, with the first cut delivered around the middle of the year. We suspect they may cut as many as 3 times, in line with what they have communicated so far.
• We remain cautious of both duration and credit risks in the short term, but over the medium term the outlook for both bond yields (other than at the long end of the curve) and risk markets is very positive.

Strategy & Positioning – Looking Forward

After multiple Fed rate cuts starting as early as March were priced into yield curves in early 2024, markets have now moved away from this expectation which, in our view, was far too optimistic.

US inflation remains well above the Federal Reserve’s target and, as forecast, has proven stubborn – the final leg down from 3% to 2% was always likely to be difficult, slow and subject to some interim upward moves.

By the end of February, some 3 to 4 rate cuts of 25bps were priced-in for 2024. We believe this pricing remains a little too optimistic, and another rate cut can and should be priced out of markets in the near term.

However, we continue to believe that the Fed will cut rates later in 2024, with the first cut delivered around the middle of the year. We suspect they may cut as many as 3 times, in line with what they have communicated so far. However, the primary risk to this scenario is, in our view, that inflation and wage growth in particular remain stubborn, and therefore fewer rate cuts are delivered.

As a result, we remain cautious of adding duration in the near term, and we are also wary of credit spreads at relatively tight levels in an environment where Central Banks could disappoint market expectations of easier monetary policy.

Looking further out in time, we remain extremely positive on fixed income markets. Rates are ultimately in deeply restrictive territory, and will need to be cut repeatedly to avoid undue pressure on economies that have been propped-up by government spending.

Yields are high, allowing investors to earn attractive carry for moderate risk, and the prospect of capital returns in addition to that carry is significant. However, it will take some time for the next leg of price appreciation to occur; it will most probably arrive with the confirmation of the first rate cut by the Fed.

In keeping with this short term caution and medium term optimism, we hold substantial exposure to some risk areas of fixed income markets, and balance this with some low risk exposure and CDS-based protective hedging. The largest allocation within our highest ever exposure to Financials is to senior European bank debt which has, in our view, very low default risk. Also within Financials, we have approximately 16% of the Fund’s NAV invested in contingent convertible / AT1 bonds. These subordinated bonds offer attractive levels of yield and the potential for further capital returns in addition as rate cuts begin.

We retain a 10% allocation to Convertible bonds where, as ever, we are biased towards issues with upside risk skew and relatively low credit risk. Recently we have been reducing exposures to US Technology names, instead taking exposure to Asia ex Japan on valuation grounds. Large cap, blue chip names with strong earnings visibility is a key theme given the uncertain economic outlook.

We have only modest exposure to High Yield bonds, preferring the risk dynamics of certain Emerging Markets, including local currency sovereign exposure to Mexico and Brazil, hard currency sovereign exposure to Bahrain and Egypt and EUR exposure to Bulgaria and Romania as they move towards Eurozone membership.
The hedging is achieved through CDS index positions. Total notional size of these positions, via the ITRAXX Senior Financial, Main (investment grade) and Crossover (high yield) indices was 28% of Fund NAV at end February.

SFDR Disclosure
The EU Sustainable Finance Disclosure Regulation (“SFDR”) requires investment firms to formalise how sustainability is integrated into their business and processes, and to make new public and client-facing disclosures on sustainability matters. The aforementioned disclosures relating to Nomura Asset Management U.K. Limited are published on our website at https://www.nomura-asset.co.uk/responsible-investment/esg-sustainable-investment/. Product related disclosures regarding Nomura Funds Ireland PLC, its sub-funds can be found in the prospectus. The Nomura Global Dynamic Bond Fund is an Art. 6 fund according to SFDR.

Disclosures
This information was prepared by Nomura Asset Management U.K. Limited from sources it reasonably believes to be accurate and is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.

The contents are not intended in any way to indicate or guarantee future investment results as the value of investments may go down as well as up.  Values may also be affected by exchange rate movements and investors may not get back the full amount originally invested. Before purchasing any investment fund or product, you should read the related prospectus and/or documentation in order to form your own assessment and judgment and, to make an investment decision. This report may not be reproduced, distributed or published by any recipient without the written permission of Nomura Asset Management U.K. Limited.

This is a marketing communication. Please refer to the prospectus and to the PRIIPs KID or UCITS KIID as appropriate for your relevant jurisdiction before making any final investment decisions. The content of this document is considered as minor non-monetary benefit in the meaning of MiFID II and not to be construed as legal, business or tax advice or as a recommendation of any kind.

The fund is a sub-fund of Nomura Funds Ireland plc, which is authorised by the Central Bank of Ireland as an open-ended umbrella investment company with variable capital and segregated liability between its sub-funds, established as an undertaking for Collective Investment in Transferable Securities under the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011. The UCITS fund is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.

The prospectus, key information document (PRIIPs KID), key investor information document (UCITS KID) – as appropriate for your relevant jurisdiction – and other fund related materials are available in English and, for the PRIIPs KIDs, in the official language of the countries in which the fund is available for distribution on the Nomura Asset Management U.K. Ltd. website at https://www.nomura-asset.co.uk/fund-documents/. Nomura Asset Management U.K. Ltd. is authorised and regulated by the Financial Conduct Authority.

The fund may invest in Emerging Markets and High Yield debt securities which tend to be more volatile than those of more developed capital markets or investment grade securities so any investment is at greater risk. The strategy may invest in derivatives including (but not limited) to futures, forwards, options, swaps and swaptions. Some of these securities are exchange traded, others are not. Derivatives traded on an exchange are guaranteed by the exchange. Derivatives that are not exchange traded carry risk of default by the counterparty. In almost all cases (other than long positions in options), the derivatives used may result in losses greater than the amount of the original investment.

At times the fund may invest in cash, near cash and / or deposits up to 100% and have derivatives exposures of up to 100% of the fund’s assets.  More details of the use of financial derivative techniques are available from the Statement of Risk Management Process of Nomura Funds Ireland plc.

A summary of investor rights in English and information on collective redress mechanisms are available at https://www.nomura-asset.co.uk/download/funds/how-to-invest/Summary_of_investor_rights.pdf. Nomura Asset Management U.K. Limited may at any time decide to terminate arrangements it may have made for the marketing of units of a fund in a member state other than its home member state.