We are in the final sprint of 2023: five reasons to choose investment grade bonds

Let's hit the track:

During the year, many bond investors believed short-term government bonds and money market funds were the right choice, capable of offering high yields with low duration risk in a tortuous inflation and rate hike environment.

Consequence was that these funds received billions in inflows. On their side, Investment grade bonds also experienced positive inflows, but at lower levels. Why then switch to these investment grade bonds and increase duration as the end of 2023 approaches?

These days, the yield curves are inverted, indicating that short-dated debt offers higher yields than longer-dated bonds with the same risk profile. It is also true that this is just a "momentum" the curves will not remain inverted like this forever: inflation is trending downward in many nations, economic growth is meanwhile slowing down, and based on the latest leaked news we are now closer than ever to the end of the rate hike cycle.

So it is time to look at new types of investments where you can fit in with your longer duration investment portfolio: if we see the average yields in percentages between 10-year and 2-year bonds in basis points we have the three situation below:

•  2-year U.S. treasury
• 10-year U.S. treasury

75 basis point difference between the former and the latter

•  2-year Schatz Germany
• 10-year Schatz Germany

45 basis point difference between the former and the latter

•  2-year Gilt England
• 10-year Gilt England

25 basis point difference between the former and the latter

Here are 5 reasons to change your approach:

• Lower reinvestment risk: Short-term investments carry reinvestment risk because you will need to reinvest the bond proceeds first. Since we all agree that we are at the end of an upward cycle, we are very close to the peak of rates so. Gradually increasing the duration of your bond investments tents to reduce reinvestment risk.

• Convexity is on your side: about 40% of the global investment large universe trades at a market price below 90, this makes the market very convex. this indicator shows the change in bond prices as a function of interest rate movements, the higher the convexity the more sensitive the prices. Greater convexity greater return in bond investment. It has been years, however, since bonds traded below par, and since in investment grade it is very rare for them to go down to default they will return to their face value. 

• Opportunities to diversify: investing in one's own comfort zone in one's own country in my opinion goes against the very basis of diversification. And because governments like the UK and Italy have credit risk, it is a mistake to think that these bonds are exempt from risk; remember the biggest ever collapse in 2022 of U.S. Treasuries? on the other hand, the investment grade bond market offers many more opportunities for diversification, over 60 countries and numerous sectors.

• Inverted yield curves are normalizing: if we go back in the past precisely to 1982, we have since found ourselves with an inverted yield curve at the end of a tightening cycle on at least five occasions. inverted curves could normalize rapidly favoring longer maturity bonds.

• Return of income: corporate bonds are a diversified source of return. The most relevant source in the long run is the income generated by high coupons, which could provide an extra return. Subordinated bonds generate even higher income, with coupons above 9% in euros. I believe, therefore, that income has made a comeback in fixed income, benefiting investors.

Why finally choose investment grade bonds now?

Assuming that the rate hike cycle is coming to an end, history teaches us that it is time to embrace a longer duration. Corporate bond yields may have peaked and offer an excellent entry point for investors today, from recent technical analysis. Corporate bonds now offer high carry, with attractive coupons and a convex risk profile-a set of opportunities we have rarely seen before.

Bicci