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 into 3Q22 after optimism about a the Fed’s potential pivot began to fade in mid-August.
Amid negative global risk sentiment, the Bloomberg US Aggregate Bond Index fell 4.8% in 3Q22, kicking off a difficult second half on a sour note.
Malaysia-centric bonds remained resilient, while Asian high-yield bonds remained deep in the red, helped by the Chinese real estate sector.
Major markets are grappling with a potent mix of high inflation and the prospect of faster-than-expected rate hikes, and bonds have sold off heavily for yet another quarter. This can be seen by the huge 8.06% drop in the Bloomberg Aggregate Bond Index, the benchmark for global bonds.
Year-to-date, Malaysia-centric bonds have remained resilient, with benchmark Malaysian government securities (MGS) yields relatively stable. At the same time, the relatively low inflation rate and stable economic data improved market confidence in Bank Negara Malaysia’s less aggressive stance.
On a less positive note, Asian high yield bonds remain deep in the red, followed closely by the global high yield bond and emerging market segments.
The aforementioned bonds were downplayed not only by rising rates, but also by a tumultuous first half plagued by a slowing Chinese housing market and the Russian-Ukrainian war.
Overall bond fund performance
At the end of the second quarter, we had a total of 65 bond funds available to investors through our platform. Of which, a total of 20 funds ended the quarter with a negative return, while 43 funds managed to deliver positive performance over the quarter.
Thus, all of these equity funds generated an average return of minus 0.3% in 3Q22.
The best performing bond funds in 3Q22 came mainly from Malaysia and global sukuk as these regions rode against negative global sentiment.
Global sukuk funds represented three of our top 10 equity funds in 3Q22, outperforming their traditional peers. Within this segment, the best performing bond fund was the Affin Hwang AIIMAN Global Sukuk fund.
This fund consistently delivers satisfactory returns to investors and has outperformed the benchmark since inception. Demand for Global Sukuk may continue to be supported by investors’ search for higher yields and quality credits.
GCC sukuk issuers remain the main beneficiaries of higher oil prices and have continued to benefit from improved credit ratings and credit outlooks from international rating agencies due to the significant improvement in the region’s economic prospects. The appreciation of the US dollar also boosted returns for global sukuk funds.
In fact, short-term bond and money market funds were also among our top performers.
The rising rate environment gives short duration bond and money market funds the opportunity to reinvest in higher yielding bonds and offers investors the potential for higher total returns over time, even if the volatility of the short-term market persists.
To top it off, short-term bond yields have risen significantly relative to long-term yields, meaning investors can receive attractive returns without having to take on greater duration and credit risk.
Meanwhile, six Malaysian funds made the top 10 list despite weaker returns across the market and a rising rate environment. Despite the recent steepening and rising yields in the bellies of the curve, we still see the opportunity to take profits in government bonds as valuations look fair after the recent rally.
In addition, the RM50 billion in dividends from Petronas to the government will also help cap government procurement issues.
Going forward, we remain positive on short-term bond funds and corporate bond funds for better yield rallies.
Worst performing bond funds in 3Q22
Moving up a gear to the worst performing funds in 3Q22, it’s worth noting that once again it was dominated by Asian-themed funds, primarily from the Chinese market.
This was due to the continued difficulties of the Chinese real estate sector and the default of some Chinese developers during the last 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 explains its lackluster performance in the quarter.
Nonetheless, we remain positive on Chinese equities as a whole: with valuations and earnings estimates at historic lows, we believe there is significant leeway for Chinese equities to outperform once the situation improves. will turn around.
Meanwhile, inflation-linked bond funds had an abysmal quarter. Following another 75 basis point hike from the Fed to fight inflation, demand for inflation protection is down.
The market expects inflation to decline, with the 10-year break-even inflation rate (or implied inflation rate) at just over 2%.
Interestingly, we see the reasons for the end of decades of low inflation. The world is entering a new regime where structural forces such as rising commodity prices, labor shortages and the threat of de-globalization will lead to a more persistent rise in inflation in the years to come.
We remain cautious about the future economic outlook. Inflation has proven persistent and the US Federal Reserve has made it clear that it will continue with aggressive rate hikes, even if it means inflicting pain on the economy.
On a more positive note, bond valuations have become more attractive after this year’s strong sell-off.
Although all risks (such as the likelihood of a recession) have not yet been reflected in valuations, global bond issuers generally have sound credit fundamentals and are therefore well positioned to weather uncertainties.
Our preference is for short duration global investment grade bonds.