Top fixed income funds 1Q 2021: The looming spectre of rising yields

Low duration fixed income at the top of the chain

The best performing fixed income fund for the first quarter is UTI Indian Fixed Income SGD. It invests mostly in Indian sovereign bonds, and high quality (AAA rated) Indian corporate bonds. One major reason why Indian government bonds rallied strongly in March was due to the Reserve Bank of India (RBI) maintaining its accommodative monetary policy stance.  Overall, the bond fund enjoyed back-to-back positive returns in February and March.

Another odd-looking fund that sticks out alongside Indian bonds, is the Franklin Floating Rate A (dis) USD fund. The fund specializes investing in bonds that reset towards the prevailing TIPs rate periodically. With inflation expectations on the rise, floating rate bonds increase in value since investors would be receiving a higher coupon income.

Chart 2: Recent uptick in inflation expectations have benefitted inflation-linked bonds

High yield bond funds of every type also feature heavily in the top 10 list. In a rising bond yield environment, high yield bond funds relative to other fixed income segments tend to be the most resilient among others due to its lower duration profile. Investors may also be increasingly positive on the credit profile high yield issuers as economic momentum picks up globally. Unconstrained and income oriented bond funds like Schroder ISF Strategic Bond A Dis USD and JPMorgan Funds – Income A (div) USD also benefitted from the revival in market sentiment.

Table 2: Top 10 performing fixed income funds for 1Q 2021

Fund name	YTD	1Q 2021	Segment
UTI Indian Fixed Income SGD	9.0%	9.0%	India Bond
Schroder ISF Strategic Bond A Dis USD	4.3%	4.3%	Global Bond
GS Asia High Yield Bond Portfolio Acc USD	4.1%	4.1%	Asian High Yield Bond
Neuberger Berman European High Yield Bond A MDis USD-H	4.0%	4.0%	Europe High Yield Bond
Franklin Floating Rate A (dis) USD	3.8%	3.8%	US Bond
UBS (Lux) Bond Fund - Euro High Yield P MDIS USD-H	3.5%	3.5%	Europe High Yield Bond
GS ESG-Enhanced Europe High Yield Bond Portfolio Acc USD-H	3.4%	3.4%	Europe High Yield Bond
GS Asia High Yield Bond Portfolio MDist USD	3.4%	3.4%	Asia excluding Japan Bond
JPMorgan Investment Funds - Global High Yield Bond A (acc) USD	3.2%	3.2%	Global High Yield Bond
JPMorgan Funds - Income A (div) USD	3.1%	3.1%	Global Bond

EM bond Investors throwing the towel

The bottom 10 performing fixed income funds for this quarter consists entirely of Emerging Markets bond funds. With the IMF forecasting Emerging Markets (as a region) to grow by 6% in 2021, why has EM bonds underperformed by such a large margin?

From a macro perspective, the recent narrative of rising real rates, as a result of rising nominal US Treasury yields, has reduced the appeal of EM bonds. This happens because EM bonds are deemed as risky, and with higher US treasury yields, investors believe can look elsewhere to attain an incrementally higher real rate of return without taking on higher idiosyncratic, credit, and foreign exchange risks that comes with Emerging Markets.

Also, additional leverage chalked up during the pandemic may become an issue for EMs moving forward. Higher rates will mean higher refinancing costs. Besides, the reality of higher rates in EMs is much closer.

Many EMs are currently dealing with higher inflation given the sharp rise in commodity prices in recent times. In particular, a number of EM central banks have started or are thinking of tightening monetary policies even though their countries may still be struggling with relatively high COVID-19 infection and death rates, and are experiencing difficulty in delivering adequate vaccinations to their populations. For many of these EMs, the road to a full reopening remains rife with challenges, and the key concern is that monetary tightening would come in the expense of growth.

Table 3: Bottom 10 performing fixed income funds for 1Q 2021

Fund name	YTD	1Q 2021	Segment
BNP Paribas Emerging Bond Opportunities RH EUR	-8.4%	-8.4%	Emerging Markets Bond
BNY Mellon Emerging Markets Debt Total Return H Acc EUR-H	-7.8%	-7.8%	Emerging Markets General Bond
PIMCO Emerging Markets Bond Fund Cl E Acc EUR-H	-7.3%	-7.3%	Emerging Markets Bond
NN (L) Emerging Markets Debt (Hard Currency) X EUR-H	-7.3%	-7.3%	Emerging Markets Bond
Neuberger Berman Emerging Market Debt Local Currency A MDis SGD-H	-7.2%	-7.2%	Emerging Markets Bond
Blackrock Emerging Markets Local Currency Bond A6 SGD-H	-6.8%	-6.8%	Emerging Markets Bond
Blackrock ESG Emerging Markets Blended Bond A2 USD	-6.4%	-6.4%	Emerging Markets Bond
Blackrock Emerging Markets Bond A2 EUR-H	-6.2%	-6.2%	Emerging Markets General
GS Emerging Markets Debt Portfolio Stable MDist SGD-H	-6.1%	-6.1%	Emerging Markets Bond
BNP Paribas Local Emerging Bond USD	-6.0%	-6.0%	Emerging Markets General Bond

US Dollar makes a counter trend rally against major currencies

Having depreciated significantly in 2020, the US dollar underwent a counter trend rally during the first three months of 2021. Using the DXY Index as a gauge for dollar strength, it has risen by close to 4% during this period. Therefore, funds with share classes denominated in USD, or are hedged to USD, have generally outperformed others. Conversely, the Euro had depreciated against the US dollar by 5%. Euro denominated share classes feature heavily on the bottom performing list.

As we mentioned in our 2021 outlook for Emerging Markets, we remain bearish on the US dollar over the medium term due to large fiscal deficits that we expect to continue at least for the foreseeable horizon. Despite its positive performance, we believe it to be a counter trend rally within a larger downtrend, of which may resume its down leg shortly. Investors who wish to express a currency view in their fixed income investments may want to consider hedged share classes (if the fund’s base currency is denominated in USD) of their preferred currencies.

Looking forward

After a torrid quarter, some investors may be tempted to have a dip in Emerging Markets credits and bonds. Overall, the case for the fixed income segment at this juncture is a little mixed. While a resumption in the US dollar weakness will certainly improve the prospects for Emerging Markets, there is little room for spread compression, which a key return driver for fixed income. Lastly, EM bonds could face pressure from interest rate risk should long end rates continue marching higher in the months ahead.

Chart 3: Credit spreads of global EM bonds (JPMorgan EMBI Global Index) at current levels aren’t that attractive

(Top equity funds 1Q 2021: Value strategies go from strength to strength)