The Attractiveness of the Opportunity Set

In 2020, we increased our exposure to emerging-markets debt (EMD), a sector that’s offered exceptional returns over the long-term (FIGURE 1), because EMD credit spreads were attractive. Yet so far in 2022, EMD has been one of the most challenged sectors in fixed-income markets, especially since it’s subject to substantial headline risk related to individual countries, as well as geopolitical risk such as the ongoing war in Ukraine and Russia. 

We believe it’s still important to consider EMD as an opportunity, not just from a valuation perspective, but because we think there’s a robust opportunity set in EM corporates and sovereigns in spite of the Russian invasion of Ukraine. We find that, in most cases, EMD offers favorable returns with attractive risk premia. The space contains corporates with robust, growing businesses and exposure to industries and regions that are often unavailable to the US-centric investor. 

Our other core position during this rate-hiking cycle is in bank loans, with their attractive spreads, seniority in the capital structure, and floating-rate payments. Bank loans have been a source of stability so far in 2022, serving as an anchor point in a volatile market. Additionally, components of ABS and securitized credit can offer attractive returns and can be important sources of return.

Hartford Strategic Income Fund contains large allocations to bank loans and high-yield bonds, which have generally performed well in rising-rate environments.

Duration

Recently, duration has been considered an unattractive feature in fixed-income portfolios. But for the Hartford Strategic Income Fund, duration has served two beneficial functions: as a source of return (FIGURE 2) and a credit hedge.

We consider the flight-to-quality and liquidity aspects of US Treasury and agency securities as a way to potentially hedge the portfolio; periodically, hedges can cause drag. That doesn’t mean that in every environment, risk assets and interest rates will be negatively correlated—just that during sharp reversals, duration may be a friend. 

In most rising-rate environments in which Treasuries performed poorly, bank loans and high-yield bonds performed well. Hartford Strategic Income Fund contains large allocations to both asset classes, which could help it withstand today’s rising-rate environment (FIGURE 3).

We think the market is ripe for dislocation, and Hartford Strategic Income Fund stands ready to take advantage of such dislocations.

Sector Rotation Is Critical Because There’s No Single Winner

The value of sector rotation is having the opportunity to take advantage of relative value differentials and expected return outcomes between credit sectors. Return laggards of prior years are often winners in the years that follow: Credit sectors that have lagged in performance often have wider spreads and higher yields than their peers that have performed well. 

Unlike most equity asset classes, fixed-income investors don’t have to wait until the market recognizes a subsector as undervalued. Instead, coupons and the natural price appreciation of a maturing bond compensate the investor. The challenge lies in making sure there are limited impairments due to defaults—an analysis that requires a fundamental review by long-tenured credit analysts.

But What About Now? 

While we expect more rate volatility, we believe that hawkish sentiment and inflation will begin to subside as 2022 and 2023 progress. More importantly, we think there are opportunities in EMD, bank loans, and securitized credit. Our long-term goal is to provide a better risk-adjusted return than individual sectors. We think this environment is ripe for dislocation in a variety of credit sectors, and the sector-rotation process behind Hartford Strategic Income Fund seeks to take advantage of such dislocations.