Unlocking markets: investing in a world of change

Dec 03, 2024

Mark Dowding, BlueBay CIO, and Mike Reed, Head of Global Financial Institutions, discuss what Trump 2.0 could mean for the US economy and markets, the challenges facing Europe, and the geopolitical landscape. With politics and policy continuing to create market volatility, Mark also emphasises the importance of skilled active management to generate alpha.

<div class=""> <div class="accordion-wrapper insight-accordion"> <h3></h3> <div class="accordion" id="insightAccordion-49776"> <div class="accordion-item"> <h2 class="accordion-header" id="insightheading"> <button class="accordion-button collapsed" type="button" data-bs-toggle="collapse" data-bs-target="#accordion-49778" aria-expanded="false" aria-controls="collapseOne"> <h5>View transcript</h5> </button> </h2> <div id="accordion-49778" class="accordion-collapse collapse" aria-labelledby="accordionheading" data-bs-parent="#insightAccordion-49776" style=""> <div class="accordion-body"> Unlocking markets: the hunt for high yield By Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management, and Mike Reed, Head of Global Financial Institutions. Mike Reed 00:04 Mike: Hello, and welcome back to Unlocking Markets, the RBC BlueBay podcast, where we bring you experts from across our firm, providing opinions on markets, global policy, sustainability, and macroeconomics, whilst highlighting how these feed into our investment decisions. I'm Mike Reed, head of Global Financial Institutions. Today I'm delighted to welcome Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management here at RBC BlueBay. High yield bonds are often viewed with caution by some investors, but have often generated returns that are greater than those from government or investment grade bonds. It will be interesting to hear from Sid, how he and his team navigate the asset class and generate returns for clients. Sid, welcome to the podcast. Sid Chhabra 00:56 Sid: Hi, Mike. Pleasure to be on. Mike Reed 00:58 Mike: Great to have you. Let's dive in. With core global interest rates having risen from their near-zero levels during the 2010s and Covid era, investors are now able to get much higher coupon rates than back then. Given this, what advantages do high yield bonds or high yield funds bring to investors? Sid Chhabra 01:20 Sid: Yes. If you think about the high yield asset class over the last 5, 10, 15 years, it's consistently delivered 300-400 basis points of excess returns over government bonds. It's not just in relation to government bonds; even compared to corporate investment grade bonds, high yield has delivered 300 basis points or thereabouts of excess returns over the last 3, 5, 7 years. Today, with higher expected rates and a broadly positive backdrop for growth, and also with defaults on the lower end, I continue to see a favourable environment for the asset class to generate strong returns for investors over the next few years. One key point to note is that the asset class has also benefited from a continued improvement in quality over the last decade, because a number of companies within the index are at lower leverage points, which is also reflected in the rating mix, with a growing proportion of these issuers being double B rated. All in all, it's an interesting and a favourable environment for the high yield asset class on a go-forward basis. Mike Reed 02:38 Mike: It's interesting to hear how the returns have been so good over such a long period of time. A lot of the investors we speak to are often very focused over a relatively shorter period of time, and your funds have delivered strong returns over the last 12 months. Given the maybe slightly uncertain current economic backdrop, do you believe they remain attractive here and now today? Sid Chhabra 03:02 Sid: Yes, Mike, very much so, actually. One of the arguments that, of course, investors will mention, is that spreads and valuations have tightened, and they have, but as we touched on earlier, with the benefit of higher base rate and generally, a backdrop of positive growth, we expect to see high single digit returns over the next 12 months. Very attractive, even though it's a little lower than the previous 12 months in this environment. High single digit type of returns, we think, are very compelling. There are a few reasons for that, in terms of how we are able to see that return profile develop. If you think about the supply picture, M&A and LBO volumes are likely to pick up over the next 12 months. We see that as a channel from which we will likely see more supply relative to what we've seen in the last couple of years. Alongside that, there are a number of high yield issuers that still need to refinance their debt. All in all, we expect the supply picture to be healthy over the next 12 months, but that's not it. There's also quite a bit of dispersion between single names in terms of where they're trading, but also within sectors, which, for investors like us, which are active, fundamental, bottom-up credit investors, that provides a very healthy ground for credit alpha generation. This is, as I mentioned, on a backdrop of good growth, stable growth, which means that defaults are not particularly high. In fact, we expect base case defaults to be closer to 2 to 2.5%, many of them coming from well-known idiosyncratic stories. If I put it all together, 2025 is going to be busy for us from a supply side, from a dispersion side, but the carry of the asset class, with high base rates and spreads in the 300-350 basis points range, means that we think it's a potential for a high single digit type of return over the next 12 months. Mike Reed 05:15 Mike: That sounds very interesting, very attractive. I'm going to come back to that point you raised about the dispersion between sectors. Something also you mentioned was you talked about LBOs. I know that with your background, you have a very deep knowledge of leveraged loans. I'd be interested to hear your thoughts on how private credit interacts with the high yield market, and how this has developed, and how this helps your investment process overall. Sid Chhabra 05:42 Sid: Yes, it's a very interesting question, and very topical as well. Firstly, what I would suggest is that the development and growth of the private credit asset class is obviously a positive for corporate issuers, because it gives them an additional channel to source financing and credit. Rather than simply relying on the public channel of, say, high yield bonds or syndicated loans, there is this other channel that is developed and grown. Secondly, private credit tends to offer solutions that typically give the sponsors financing at higher leverage points, many times at six turns or greater leverage versus the high yield market that is, on average, hovering around three turns of leverage. The positive dynamic for the high yield market comes from the growth of private credit asset class and loans, because what's tended to happen is that smaller issuers and mid-scale issuers, owned by PE sponsors, have had this other channel to get credit and financing. They've gravitated towards private credit, which has allowed them, also, to get financing with higher leverage, leaving behind the high yield asset class, which, as I mentioned, is hovering at lower leverage, call it two and a half to three and a half turns, also therefore a higher quality asset class within the broader leveraged finance space. As I mentioned previously, the majority of the index is double B rated, and so, the development and growth of private credit has actually been a positive technical for high yield. Mike Reed 07:16 Mike: That's very interesting. I'm not sure investors are very aware of how the market has developed and this movement, as you said, of the improvement in the credit rating of the index overall has been now double B, and I think that's very important in how investors look at it, going forward, in terms of its risk profile. Now, one thing I said earlier, I was going to come back to, which you touched on with the dispersion across sectors; and so, if you look across the markets today, which sectors do you feel offer particularly good opportunities, in your view and your team’s view, and obviously, which areas are causing you concern? Sid Chhabra 07:53 Sid: Yes. There are a few sectors that we like. We like these sectors for different reasons. For example, banks. Banks continue to report good earnings, strong earnings, and that's translating into improved profitability metrics. We like that sector. On a spread and carry basis, that sector is still trading wide, so we see good opportunities within that sector, and we are investing quite actively within banks and financial services. A different sector that tends to be cyclical, like the energy sector, actually is also providing options for total return, particularly from the new issue market, because there's a lot of refinancing as well as corporate actions which are taking place within that sector. Although being a cyclical sector, it is providing compelling single name return opportunities that help provide alpha within our funds. Telecoms sector, again, a well-known sector, but one that we continue to like, is a sector where there are a few single name issues. By and large, it's a sector that benefits from generally stable revenues that are growing. Within that sector, we have generally focused on those names which have an asset-rich base of infrastructure underlyings. We have taken picks within that sector, where there is an angle beyond just the earning profile. I would say another sector that has had challenges over the last two years that, for us, this year, has been an active hunting ground, has been the real estate sector, and their issuers have had to grapple with higher rates, and previously, financing that was extended at stretched valuations. There's been more stress in the sector over the last 12-24 months, but this year, on the back of lower rates, particularly in Europe, there's been more compelling and interesting opportunities for us to capture value. We have been active in that sector as well. A sector that we are cautious on, and we actually expect stress to develop a bit further, is European autos. We have been expecting lower profitability coming from China for a large number of the European OEMs, but also on the back of lower EV sales. We're starting to see this in earnings. In fact, in the last couple of months, I'm sure many have heard about the weakness, margins, and profitability of the European auto OEMs, as well as suppliers. We don't think this is the end. We expect to remain cautious with, also, potential tariff newsflow picking up as well. We think this will translate to a bit more pressure on margins. Overall, if there was a sector that I would say that we remain somewhat cautious, it is on the European auto side. Mike Reed 10:54 Mike: Thank you. That's very helpful and also helps me because it gives me a lead into my next question. There's a lot of debate of passive versus active. Here at RBC BlueBay, we run active investment strategies very successfully over the years. I'd be interested to know a bit further, a bit more meat on the bones, how does your team actually add value to investors? Sid Chhabra 11:18 Sid: Yes. RBC BlueBay has been investing in the high yield market now for over 20 years. We have a large and very experienced global team. We have something like 20 analysts and over 10 portfolio managers. Actually, many of our analysts and PMs have 15, 20, 25 years of experience. What that means is that many of the issuers within the leveraged finance market, within the high yield market, we have followed their earnings, their performance, through many cycles. That gives us, in our view, an edge, because our team knows these names really well, knows the issuers really well, have understood the dynamics of these issuers extremely well. Alongside that, if you look at our platform today, we have nearly 20 billion in assets that we manage within the leveraged finance cohort across global funds, loan funds, different types of vehicles, benchmark vehicles, as well as total return vehicles. Because of the pace of AUM that we have, we're also very much a key counterparty to sponsors and dealers. When you combine that platform that we have, the size of the team that we have, the experience in the team that we have, and our connectivity with market, including dealers and sponsors, it does give us an edge in the way we express credit views in portfolio construction. That ultimately leads to better longer-term performance. Our value comes, I think, to our investors who allocate with us, because we have a strong base. We have a strong team. We have a global team. We have an experienced team. We have, in my view, a very thoughtful investment process that's been time-tested. It's quite robust. If you put those elements together, ultimately, that leads to strong performance. I think we have generally delivered that over the last 5-10 years. Mike Reed 13:24 Mike: Well, that's very clear. I think investors will see that your team, over the years, has created value for investors and that your active style has definitely outperformed a passive one. Thank you, Sid. It was really great to get your perspective on the high yield market and the current opportunities, and also how you and your team work to generate alpha for investors in our funds. Sid Chhabra 13:48 Sid: Well, thank you, Mike. Thanks for having me. Mike Reed 13:50 Mike: It's been great having you on. Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. The podcast will be back soon, with more insights from the portfolio managers at RBC BlueBay, which we hope will help you navigate the investment landscape across both equities and fixed income. Thank you, once again, for joining us today. Good luck, and goodbye. </div> </div> </div> </div> </div> </div><div class=""> <div class="accordion-wrapper insight-accordion"> <h3></h3> <div class="accordion" id="insightAccordion-49776"> <div class="accordion-item"> <h2 class="accordion-header" id="insightheading"> <button class="accordion-button collapsed" type="button" data-bs-toggle="collapse" data-bs-target="#accordion-49778" aria-expanded="false" aria-controls="collapseOne"> <h5>View transcript</h5> </button> </h2> <div id="accordion-49778" class="accordion-collapse collapse" aria-labelledby="accordionheading" data-bs-parent="#insightAccordion-49776" style=""> <div class="accordion-body"> Unlocking markets: the hunt for high yield By Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management, and Mike Reed, Head of Global Financial Institutions. Mike Reed 00:04 Mike: Hello, and welcome back to Unlocking Markets, the RBC BlueBay podcast, where we bring you experts from across our firm, providing opinions on markets, global policy, sustainability, and macroeconomics, whilst highlighting how these feed into our investment decisions. I'm Mike Reed, head of Global Financial Institutions. Today I'm delighted to welcome Sid Chhabra, head of European High Yield, Securitized Credit and CLO Management here at RBC BlueBay. High yield bonds are often viewed with caution by some investors, but have often generated returns that are greater than those from government or investment grade bonds. It will be interesting to hear from Sid, how he and his team navigate the asset class and generate returns for clients. Sid, welcome to the podcast. Sid Chhabra 00:56 Sid: Hi, Mike. Pleasure to be on. Mike Reed 00:58 Mike: Great to have you. Let's dive in. With core global interest rates having risen from their near-zero levels during the 2010s and Covid era, investors are now able to get much higher coupon rates than back then. Given this, what advantages do high yield bonds or high yield funds bring to investors? Sid Chhabra 01:20 Sid: Yes. If you think about the high yield asset class over the last 5, 10, 15 years, it's consistently delivered 300-400 basis points of excess returns over government bonds. It's not just in relation to government bonds; even compared to corporate investment grade bonds, high yield has delivered 300 basis points or thereabouts of excess returns over the last 3, 5, 7 years. Today, with higher expected rates and a broadly positive backdrop for growth, and also with defaults on the lower end, I continue to see a favourable environment for the asset class to generate strong returns for investors over the next few years. One key point to note is that the asset class has also benefited from a continued improvement in quality over the last decade, because a number of companies within the index are at lower leverage points, which is also reflected in the rating mix, with a growing proportion of these issuers being double B rated. All in all, it's an interesting and a favourable environment for the high yield asset class on a go-forward basis. Mike Reed 02:38 Mike: It's interesting to hear how the returns have been so good over such a long period of time. A lot of the investors we speak to are often very focused over a relatively shorter period of time, and your funds have delivered strong returns over the last 12 months. Given the maybe slightly uncertain current economic backdrop, do you believe they remain attractive here and now today? Sid Chhabra 03:02 Sid: Yes, Mike, very much so, actually. One of the arguments that, of course, investors will mention, is that spreads and valuations have tightened, and they have, but as we touched on earlier, with the benefit of higher base rate and generally, a backdrop of positive growth, we expect to see high single digit returns over the next 12 months. Very attractive, even though it's a little lower than the previous 12 months in this environment. High single digit type of returns, we think, are very compelling. There are a few reasons for that, in terms of how we are able to see that return profile develop. If you think about the supply picture, M&A and LBO volumes are likely to pick up over the next 12 months. We see that as a channel from which we will likely see more supply relative to what we've seen in the last couple of years. Alongside that, there are a number of high yield issuers that still need to refinance their debt. All in all, we expect the supply picture to be healthy over the next 12 months, but that's not it. There's also quite a bit of dispersion between single names in terms of where they're trading, but also within sectors, which, for investors like us, which are active, fundamental, bottom-up credit investors, that provides a very healthy ground for credit alpha generation. This is, as I mentioned, on a backdrop of good growth, stable growth, which means that defaults are not particularly high. In fact, we expect base case defaults to be closer to 2 to 2.5%, many of them coming from well-known idiosyncratic stories. If I put it all together, 2025 is going to be busy for us from a supply side, from a dispersion side, but the carry of the asset class, with high base rates and spreads in the 300-350 basis points range, means that we think it's a potential for a high single digit type of return over the next 12 months. Mike Reed 05:15 Mike: That sounds very interesting, very attractive. I'm going to come back to that point you raised about the dispersion between sectors. Something also you mentioned was you talked about LBOs. I know that with your background, you have a very deep knowledge of leveraged loans. I'd be interested to hear your thoughts on how private credit interacts with the high yield market, and how this has developed, and how this helps your investment process overall. Sid Chhabra 05:42 Sid: Yes, it's a very interesting question, and very topical as well. Firstly, what I would suggest is that the development and growth of the private credit asset class is obviously a positive for corporate issuers, because it gives them an additional channel to source financing and credit. Rather than simply relying on the public channel of, say, high yield bonds or syndicated loans, there is this other channel that is developed and grown. Secondly, private credit tends to offer solutions that typically give the sponsors financing at higher leverage points, many times at six turns or greater leverage versus the high yield market that is, on average, hovering around three turns of leverage. The positive dynamic for the high yield market comes from the growth of private credit asset class and loans, because what's tended to happen is that smaller issuers and mid-scale issuers, owned by PE sponsors, have had this other channel to get credit and financing. They've gravitated towards private credit, which has allowed them, also, to get financing with higher leverage, leaving behind the high yield asset class, which, as I mentioned, is hovering at lower leverage, call it two and a half to three and a half turns, also therefore a higher quality asset class within the broader leveraged finance space. As I mentioned previously, the majority of the index is double B rated, and so, the development and growth of private credit has actually been a positive technical for high yield. Mike Reed 07:16 Mike: That's very interesting. I'm not sure investors are very aware of how the market has developed and this movement, as you said, of the improvement in the credit rating of the index overall has been now double B, and I think that's very important in how investors look at it, going forward, in terms of its risk profile. Now, one thing I said earlier, I was going to come back to, which you touched on with the dispersion across sectors; and so, if you look across the markets today, which sectors do you feel offer particularly good opportunities, in your view and your team’s view, and obviously, which areas are causing you concern? Sid Chhabra 07:53 Sid: Yes. There are a few sectors that we like. We like these sectors for different reasons. For example, banks. Banks continue to report good earnings, strong earnings, and that's translating into improved profitability metrics. We like that sector. On a spread and carry basis, that sector is still trading wide, so we see good opportunities within that sector, and we are investing quite actively within banks and financial services. A different sector that tends to be cyclical, like the energy sector, actually is also providing options for total return, particularly from the new issue market, because there's a lot of refinancing as well as corporate actions which are taking place within that sector. Although being a cyclical sector, it is providing compelling single name return opportunities that help provide alpha within our funds. Telecoms sector, again, a well-known sector, but one that we continue to like, is a sector where there are a few single name issues. By and large, it's a sector that benefits from generally stable revenues that are growing. Within that sector, we have generally focused on those names which have an asset-rich base of infrastructure underlyings. We have taken picks within that sector, where there is an angle beyond just the earning profile. I would say another sector that has had challenges over the last two years that, for us, this year, has been an active hunting ground, has been the real estate sector, and their issuers have had to grapple with higher rates, and previously, financing that was extended at stretched valuations. There's been more stress in the sector over the last 12-24 months, but this year, on the back of lower rates, particularly in Europe, there's been more compelling and interesting opportunities for us to capture value. We have been active in that sector as well. A sector that we are cautious on, and we actually expect stress to develop a bit further, is European autos. We have been expecting lower profitability coming from China for a large number of the European OEMs, but also on the back of lower EV sales. We're starting to see this in earnings. In fact, in the last couple of months, I'm sure many have heard about the weakness, margins, and profitability of the European auto OEMs, as well as suppliers. We don't think this is the end. We expect to remain cautious with, also, potential tariff newsflow picking up as well. We think this will translate to a bit more pressure on margins. Overall, if there was a sector that I would say that we remain somewhat cautious, it is on the European auto side. Mike Reed 10:54 Mike: Thank you. That's very helpful and also helps me because it gives me a lead into my next question. There's a lot of debate of passive versus active. Here at RBC BlueBay, we run active investment strategies very successfully over the years. I'd be interested to know a bit further, a bit more meat on the bones, how does your team actually add value to investors? Sid Chhabra 11:18 Sid: Yes. RBC BlueBay has been investing in the high yield market now for over 20 years. We have a large and very experienced global team. We have something like 20 analysts and over 10 portfolio managers. Actually, many of our analysts and PMs have 15, 20, 25 years of experience. What that means is that many of the issuers within the leveraged finance market, within the high yield market, we have followed their earnings, their performance, through many cycles. That gives us, in our view, an edge, because our team knows these names really well, knows the issuers really well, have understood the dynamics of these issuers extremely well. Alongside that, if you look at our platform today, we have nearly 20 billion in assets that we manage within the leveraged finance cohort across global funds, loan funds, different types of vehicles, benchmark vehicles, as well as total return vehicles. Because of the pace of AUM that we have, we're also very much a key counterparty to sponsors and dealers. When you combine that platform that we have, the size of the team that we have, the experience in the team that we have, and our connectivity with market, including dealers and sponsors, it does give us an edge in the way we express credit views in portfolio construction. That ultimately leads to better longer-term performance. Our value comes, I think, to our investors who allocate with us, because we have a strong base. We have a strong team. We have a global team. We have an experienced team. We have, in my view, a very thoughtful investment process that's been time-tested. It's quite robust. If you put those elements together, ultimately, that leads to strong performance. I think we have generally delivered that over the last 5-10 years. Mike Reed 13:24 Mike: Well, that's very clear. I think investors will see that your team, over the years, has created value for investors and that your active style has definitely outperformed a passive one. Thank you, Sid. It was really great to get your perspective on the high yield market and the current opportunities, and also how you and your team work to generate alpha for investors in our funds. Sid Chhabra 13:48 Sid: Well, thank you, Mike. Thanks for having me. Mike Reed 13:50 Mike: It's been great having you on. Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. The podcast will be back soon, with more insights from the portfolio managers at RBC BlueBay, which we hope will help you navigate the investment landscape across both equities and fixed income. Thank you, once again, for joining us today. Good luck, and goodbye. </div> </div> </div> </div> </div> </div>_

Unlocking markets: investing in a world of change

By Mark Dowding, BlueBay CIO, and Mike Reed, Head of Global Financial Institutions.

Mike Reed 00:04
Mike: Hello, and welcome back to Unlocking Markets, the RBC BlueBay podcast where we bring you experts from across our firm, providing opinions on markets, global policy, and macroeconomics, whilst highlighting how these feed into our investment decisions. I'm Mike Reed, head of Global Financial Institutions. Today, I'm delighted to welcome back Mark Dowding, the Chief Investment Officer for Fixed Income here at RBC BlueBay. Mark, with so many talking points in global markets right now, it's great to have you back on the show to hear your views and get your thoughts on what opportunities exist for investors in the coming year. Welcome back.

Mark Dowding 00:42
Mark: Hi, there, Mike. Yes, it's great to be on. As you highlight, it's maybe a time where we see plenty of volatility in markets, don't we, against the backdrop of quite a lot of economic uncertainty, political uncertainty, geopolitical uncertainty. There's plenty to get you thinking as we move into the year ahead.

Mike Reed 01:04
Mike: Yes, definitely a lot to discuss. I guess it's impossible to start any conversation right now without talking about President Trump and the impact his new administration will have on both the global economy and markets. It is early days, but what would be your thoughts on how this is likely to play out over the coming 12 months?

Mark Dowding 01:23
Mark: Yes. Look, it does promise to be interesting, doesn't it? Trump 2.0. We feel that with Donald Trump, we know by now that there'll always be a degree of chaos. When it comes to headlines and soundbites, clearly, we half expect Donald Trump to be saying outrageous things. I guess the question as investors, we're sometimes asking ourselves, is ‘is the bark worse than the bite?’ I guess time will tell, history will judge.

Otherwise, I think the other things that we would highlight here is, look, when it comes to some of what has been discussed around trade policy, fiscal policy, even immigration policy, we're looking at facets of change here, many of which could actually end up adding to inflationary pressure in the US economy. On the back of that, I think the idea that interest rates are going to be coming down through the course of the coming year now is much more uncertain. Who knows? We could see rates go lower still, but you could be in a world where rates start going up again, this time next year, if things go in the other direction.

Mike Reed 02:41
Mike: Yes. Talking about interest rates, as you said, at the start of 2024, there were a lot of people talking about large interest rate cuts. I think people were talking about seven interest rate cuts in the market was predicted. We've had a couple. People were saying that people should ramp up their exposure to fixed income products back then to benefit from rate cuts. We've not really seen that. What do you think into 2025? What do you anticipate? You've touched on it a little bit. If you could elaborate, that would be great.

Mark Dowding 03:10
Mark: Yes. In this regard, we've tended to think that there'll probably be one more rate cut to come from the Fed in December or January, by which time the Fed will have done 100 basis points of rate cuts. Thereafter, I think they'll go on pause for a time. The economy is still doing pretty well. The outlook remains pretty robust for the time being. Actually, pausing at that time for the Fed will probably give them some time to be able to analyse the actions and implications of the incoming administration. As we look later in the year, I think that we can really think about scenarios.

There will be a scenario where, of course, growth may slow, and interest rates may come down. In that situation, let's say you've got the Fed cutting by 100 basis points. On the other side, if we do end up with growth still strong and inflation going up, I think that if inflation rises again, there's a pain threshold that the Fed will have to respect. If inflation is going above 3 1/2 and on a rising trajectory, they will be pushed to hike rates later in the year, because having taken their eye off the ball on inflation in 2021, I simply don't think that they can afford to do so again.

From that perspective, when we look at different scenarios, and we weigh up the probabilities, ultimately, it leads us to an investment conclusion that the market pricing of two-year rates, somewhere between 4 1/4 and 4 1/2 on US two-years, that looks pretty much appropriate and fair value to us. Though we do tend to continue to be circumspect when it comes to longer-dated bonds. I do worry this theme of oversupply of government bonds will only actually change when the fiscal paradigm changes, and you end up with governments no longer adding spending or cutting taxes.

I almost feel that it's almost inevitable that the yield curve will need to steepen in order for that to be the case. I think I'm more excited about the idea of yield curve steepening right now, rather than movements in outright direction. That would be something that I'm really carrying as a thought, as we head into 2025.

Mike Reed 05:25
Mike: That's great. It's very interesting, looking forward, seeing what's going to happen in 2025, seeing as everyone, we seem to be….well, a lot of people were very wrong about 2024. Let's move away from the US now. It's clear that both Europe and China face real potential challenges now. How are you and your teams in your portfolios positioning to avoid these risks and take advantage of any opportunities that might arise?

Mark Dowding 05:51
Mark: Yes, it's quite striking, isn't it? We continue to see this ongoing US growth exceptionalism. Certainly, in Europe, the backdrop is looking a lot more challenged. I just think that with energy costs being as high as they are in Europe, you struggle to see how European industry can really be competitive. We've also seen the challenges when it comes to security in Europe; if Trump is no longer sending dollars to Ukraine, you've got a situation on Europe's border, which Europe will really need to address and wake up to.

There are areas here where we think that ultimately, you may end up with Europe going down a path where you do see more investment, more fiscal deployment. I know the Schwarze Null, the ‘black zero’ in Germany, is limiting the German use of the fiscal space that they do have today. That probably won't change ahead of the elections in Germany, at the end of February. Thereafter, it wouldn't surprise me if we don't end up with a more expansive policy, because otherwise, you may slide from an economic crisis towards a political crisis in Europe.

This theme, this theme in terms of where we're going, I think, again, might speak to a steeper yield curve in the context of European markets. It's also a theme that I think points perhaps to underperformance of the euro relative to the dollar, and also relative to the Japanese yen, where interest rates, of course, will be going in another direction. As for China, I think really there, the issue is that the economy remains weak. While the authorities in Beijing remain committed to the idea that as they ease policy, all they're trying to do is ramp up investment and production, and effectively export their way out of their problems.

I think that these sorts of moves and initiatives, they could be destined to fall a little bit flat. Ultimately, we think that Beijing needs to really sort of empower the domestic consumer. The problem about empowering the consumer is you may then not be able to control the consumer. That doesn't really sit very well with the way in which the Communist Party is thinking and running the show. From a medium-term perspective, we’re still pretty downbeat on China, to be honest. I think it's the country that gets old before it gets rich, rather than rich before it ages.

From that point of view, it's more circumspect. It does mean that investing in this world where you've got US rates higher for longer, where you've got trade policy adverse, I just think we're going to be in a world really, Mike, where actually thinking about relative value opportunities is probably going to be more important to us than actually saying, "I love this asset class," or "I love that asset class." It's more about using your skill as an active investor to generate returns by really looking at what you like and what you don't like, because there is going to be a lot of dispersion along with volatility, I think.

Mike Reed 09:08
Mike: Mark, you touched on the conflict in Ukraine. It's also been more than a year since Israel occupied the Gaza Strip, immediately after the Hamas attacks on Israel. Despite huge loss of life, neither conflict appears near ending, and both have the potential to escalate further. Do you see risk to global markets overall from these wars in the next year?

Mark Dowding 09:30
Mark: Yes, it's been a sad time, hasn't it? Look, when it comes to Ukraine, I feel that with Trump pulling back support, you're going to end up with an outcome where we think we go towards a peace deal being imposed under a country which remains a partition country, effectively with a DMZ down the middle of it. We may effectively end up with a new Cold War kind of setting, we think is the direction of travel of things in Ukraine.

As for the Middle East, I could be more hopeful that you'll end up with a ceasefire in Lebanon. However, the sad situation in Gaza remains very problematic, with the fact that the hostages continue to be a motivator for the Israeli authorities to continue to act in a pretty harsh fashion on the civilian population there. I don't really see that getting fixed in a hurry, but I guess you can say, perhaps this doesn't have too much of a bearing on financial markets. It's only really if oil prices were to materially rise, that that would be different. We're actually at a time of effectively oversupply in the oil market.

Another thing that I would say that Trump will be doing is, day one in that administration, he'll be doing an executive order to issue permits. ‘Drill, drill, drill’ will be the mantra because he's hoping that he might be able to lower energy prices, and that may offset some of the more inflationary aspects of his agenda elsewhere. Otherwise, in the next four years, I do think that the focus more geopolitically is probably more towards China, more towards Taiwan. That's really what I'd be more inclined to worry about next.

Mike Reed 11:23
Mike: Looking back at the events of 2024, how have they impacted returns within the fixed income products you manage? Obviously, the billion-dollar question is, given your market outlook, how you've just described, how do you see asset prices behaving in the next 12 months?

Mark Dowding 11:40
Mark: In terms of the past year, what we've actually seen is longer-dated bond yields move a bit higher, largely because the slowdown, the recession that many investors maybe were looking for 12 months ago has just failed to show up. On the back of that, it's not been a great year for benchmark returns from a lot of high-quality fixed income. Obviously, high yield has done a lot better from that.

The pricing out of recession risks has been positive for high yield and for credit spreads. Effectively, what we have seen in 2024 is, even though it's not been a great year for absolute returns, it's actually been a year where we've had a lot of opportunity to generate really strong active returns through active management. We've benefited out of the idea that we've been able to play some of the volatility that's been driven by politics and policy, positioning on the right side when it came to the French elections or the US presidential elections and anticipating some of the trends across markets really rather well.

Both in absolute return strategies, as well as benchmark strategies, I'm very pleased at how the year has worked out. I do think this theme about volatility, and the volatility being linked to what's happening in politics and policy, continues to be a theme as we go into 2025. In as much as this is an area of focus in terms of our analysis, I'm very hopeful that we can continue to be on the right side of markets through the course of next year as well.

In many respects, bearing in mind, of course, in a world where yield curves have been inverted, you're not really being paid a lot for owning duration at this particular moment in time. I'm not sure that I would be projecting a very, very bumper year for fixed income indices next year. I do think that we are in a landscape where active returns can be another good year ahead. At the end of the day, we're not really in the business of trying to predict or control the absolute market level. What we feel that we can control will be our own active performance.

Mike Reed 14:08
Mike: Yes, I can see you are almost as passionate about active management strategies as you're about Chelsea Football Club here. I just wanted to..we see year after year, passive funds, the flows are very strong, ETF products in every asset class now, you can imagine. Do you really believe that active management can deliver the alpha generation that justifies the high fees that they generally charge?

Mark Dowding 14:32
Mark: Certainly yes, Mike. All I can do is present the case for the defence by sharing our track records. I think they speak to themselves. The fact that even in asset classes like, let's take government fixed income, having beaten benchmarks for 14 years in a row, I don't like to boast, but it speaks to the fact that there is opportunity for skilled managers to deliver those returns.

And so particularly in inefficient asset classes like fixed income, where you have term premia, credit premia, volatility premia, liquidity premia, in a situation where you have a market where a lot of people who own fixed income aren't even return maximising, against a backdrop where you've got continuous new issuance of new securities, this is actually an investment universe where there is an abundance of opportunity for skilled investors.

I struggle to get my head around why people would want to chase into passive fixed income, unless they've had a very bad experience elsewhere. Otherwise, I've said it before, I'll say it again, it's a muppet choice to be in passive fixed income.

Mike Reed 15:45
Mike: I like that phrase. Right now, I just hope that maybe Spurs in 2025 can match the win-loss ratio of the BlueBay fixed income strategy, because for Spurs, as a Spurs fan, it hasn't been a great year. Anyway, Mark, as always, great to get your perspective on global markets. Thank you very much indeed for being on the show.

Mark Dowding 16:03
Mark: Thanks, Mike.

Mike Reed 16:05
Mike: Thanks, everyone, for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. Next time on the show, we'll be joined by Phil Langham, head of our Emerging Market Equities team. Given all the rhetoric on tariffs from President Trump, it will be very interesting to hear how Phil thinks these companies in his universe will manage. If you wish to listen to any of the previous editions of the Unlocking Markets podcast, they are available on our website, www.bluebay.com, or can be found on Apple or Spotify or Google, whatever your platform of choice is. Thank you once again for joining us today. Good luck and goodbye.

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How might ‘Trump Trades’ play out in the year ahead?

Rate cuts: keep calm and carry on cutting!

Why do fixed income ETFs underperform their benchmarks?

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