THE second half of 2022 did not start as well as most investors expected, as bond markets generally extended their year-to-date (YTD) declines in 3Q22 after optimism over a potential Fed pivot started fading in mid-August.
Amidst negative global risk sentiment, the Bloomberg US Aggregate Bond Index fell by 4.8 per cent in 3Q22, kickstarting a challenging second half of the year on a sour note.
Malaysia-centric bonds remained resilient, while Asian high yield bonds remain deep in the red, contributed by the Chinese real estate sector.
The broad markets are struggling with a potent mix of elevated inflation and the prospect of faster-than-expected rate hikes, and bonds were sold off sharply for yet another quarter. This can be seen from the huge decline of 8.06 per cent of Bloomberg Aggregate Bond Index, the benchmark for global bonds.
YTD, Malaysia-centric bonds remained resilient as benchmark Malaysian Government Securities (MGS) yields were relatively stable.. Meanwhile, the relatively lower inflation rate and stable economic data have improved market confidence on the lesser aggressive stance from Bank Negara Malaysia.
On a less positive note, Asian high yield bonds remain deep in the red, closely being followed by the global high yield and emerging markets bond segments.
The aforementioned bonds have been beaten down not only because of rising rates, but also a tumultuous first half of the year plagued by the downturn in China’s property market and the Russia-Ukraine war.
Global bond market performance in 3Q22.
3Q22 return distributions for bond funds.
Overall bond fund performance
As of the end of second quarter, we had a total of 65 bond funds that were available for investors through our platform. Among which, there were a total of 20 funds ended the quarter with a negative return, while 43 funds managed to deliver positive performances over the quarter.
With that, all these equity funds resulted in an average return of minus 0.3 per cent in 3Q22.
The Top performing bond funds in 3Q22 were mostly from Malaysia and global sukuk as these regions rode against the current of the negative global sentiment.
Global sukuk funds accounted for three of our top 10 equity funds in 3Q22, outperforming its conventional peers. Within this segment, the top-performing bond fund was the Affin Hwang AIIMAN Global Sukuk Fund.
This fund is consistent at delivering satisfying return for investors and has outperformed the benchmark since inception. Demand for Global Sukuk may continue to be supported by investors’ hunt for higher yields and quality credits.
GCC sukuk issuers remain the prime beneficiaries of higher oil prices and continued to receive credit rating and credit outlook upgrades from international rating agencies on the back of the region’s significantly improved economic prospects. The US dollar appreciation also boosted the returns of the global sukuk funds.
As a matter of fact, short duration and money market bond funds also graced their presence amongst our top performers.
The rising rate environment bestows short duration and money market bond funds with the ability to reinvest into higher-yielding bonds and provide investors with the potential for higher total returns over time, even if near-term market volatility persists.
To top things off, short-term bond yields have moved significantly higher as compared to long-term yields, implying that investors can receive alluring yields without having to take on greater duration and credit risk.
Meanwhile, there were six Malaysian funds making into the top 10 list despite weaker returns recorded in the broad market and rising rate environment. Despite the recent steepening and higher yields in the bellies of the curve, we still see opportunity to take profits on the government bonds as valuations seem fair after the recent rally.
Also, Petronas’ RM50 billion of dividends to the government will also help to cap the supply issuances from the Government.
Moving forward, we continue to remain positive on short duration bond funds and corporate bond funds for better yield pickups.
Top performing bond funds of 3Q22.
Worst performing bond funds of 3Q22.
Bottom performing bond funds of 3Q22
Shifting gears over to the bottom performing funds of 3Q22, it is worth noting that once again it has been dominated by Asia-themed funds, most prominently from the China market.
This was due to the ongoing Chinese property sector woes and the default on few Chinese developers in the past quarter.
Notably, despite being a global fund, the worst performing bond fund in 3Q22 – Eastspring Investments Global Target Income Fund has the highest exposure to China, which explained its lackluster performance in the quarter.
Nonetheless, we remain positive on Chinese equities as a whole: with valuations and earnings estimates at all-time lows, we think there is significant room for Chinese equities to outperform once the situation turns around.
Meanwhile, inflation-linked bond funds experienced an abysmal quarter. In wake of another 75 basis points hike from the Fed to fight inflation, the demand for inflation protection is falling.
The market is expecting inflation to come down, with the 10-year breakeven inflation rate (or implied inflation rate) at just over two per cent.
Interestingly, we see reasons for decades of low inflation coming to an end. The world is moving into a new regime where structural forces such as higher commodity prices, labour shortage, and the threat of deglobalisation will lead to a more persistent rise in inflation in the years ahead.
Looking forward
We remain cautious of the economic outlook ahead. Inflation has proven to be sticky, and the US Federal Reserve has made it clear that it will follow through with aggressive rate hikes, even if it means inflicting pain on the economy.
On a more positive note, the valuations of bonds have turned more attractive after the sharp sell-off this year.
While not all risks (such as the probability of a recession) have been reflected in valuations yet, global bond issuers generally have sound credit fundamentals and hence are in a good shape to weather the uncertainties.
Our preference is for global investment grade, short duration bonds.
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