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“Beyond Markets” by Julius Baer is a series featuring conversations with experts to share recent market developments, key insights, and strategic inputs from around the globe. In each episode, we cut through the noise to offer practical advice and macro research on today’s shifting economic and market landscape.
The information contained in this podcast is marketing material. Opinions expressed do not constitute independent financial/investment research, investment advice, or an offer to buy or sell securities by Julius Baer. Please refer to www.juliusbaer.com/legal/podcasts for important legal information prior to listening to this podcast.
Jonathan Liang: If we listen to Trump, he wants to do tariffs, he wants to reduce taxes, reduce immigration, and he wants to deregulate various businesses. This is all very good for corporates even though inflation might reheat a little bit.
Dario Messi: Inflation is generally something that bond investors just don't like, so I think you probably don't want to have big duration bets out there, especially if the extra yield is not very meaningful when you extend your duration exposure.
Intro: Hello and welcome to Beyond Markets by Julius Baer, a series featuring conversations with experts to share recent market developments, key insights and strategic inputs from around the globe.
Elaine Ngim: Welcome to today's discussion. My name is Elaine Ngim, and I am Head of Investment Advisory Singapore at Julius Baer. We started 2025 with some significant market movements and key events shaping investor sentiment. Elevated political uncertainties continue to drive rate volatility while factors like new tariffs, inflation pressures, and concerns over full-fledged trade wars are weighing on global growth expectations. To break this all down, I'm joined by Dario Messi, Head of Fixed Income Research at Julius Baer, and Jonathan Liang, Head of Fixed Income Investment Specialists, Asia ex-Japan at JP Morgan Asset Management.
We'll be discussing key themes in the credit market and how investors can navigate these uncertainties. Welcome to you both.
Dario Messi: Hi, Elaine.
Jonathan Liang: Hi, Elaine. Thanks for having me.
Elaine Ngim: Let's start with a burning question for all of us. That's on inflation. Consumer expectations of inflation have risen significantly with the latest University of Michigan consumer sentiment survey showing their highest levels since November 2023. Dario, how should investors position if inflation starts to accelerate again?
Dario Messi: Yeah. Well, look, first of all, inflation, or also to be a bit more precise, unexpected inflation is generally something that bond investors just don't like. So, bonds are ultimately nothing else than a nominal contract and nominal claim. So, if inflation accelerates and we move higher again in nominal terms, these old contracts are just worth less. Now how to position for this or how to protect against this?
I think you probably don't want to have big duration bets out there, especially if the extra yield is not very meaningful when you extend your duration exposure. And then I would also say it totally depends here on where the inflation is coming from. So if it's inflation in a low growth environment, kind of a stagflationary environment, then you would typically want to have safer bonds, or the best choice would actually be inflation protected securities such as TIPS. But for now, however, we still observe a very solid US economy, a strong consumer there. So in other words, inflation is more also still demand driven.
And companies benefit from higher nominal growth. And in such an environment, I still strongly believe that some healthy corporate credit risk exposure is still a preferred choice here, even if or exactly because inflation accelerates.
Elaine Ngim: Thank you, Dario. Jonathan, how would you position portfolios then against this backdrop?
Jonathan Liang: Well, to Dario's point earlier, The US economy is still in pretty good shape. And even though we did see recent inflation reheat a little bit, the path forward really will depend on, ultimately, what the US government's policies are. Because if we listen to Trump, he wants to do tariffs, he wants to reduce taxes, he wants to reduce immigration, and he wants to deregulate various businesses.
This is all very good for corporates even though inflation might reheat a little bit. So we think that maybe longer end yields may move up a little bit, ie. the so-called term premium may increase a little bit. So we agree with Dario that now's not the time to take big duration bets. So we're staying very cautious on the duration side.
We also wanna maintain the flexibility to have duration hedges in our portfolios to protect against any rise in yields. But in the meantime, on the long end, we would like to have a high carry in our portfolios, and certain credit sectors today still offer that, around even 6% or more in many cases.
Elaine Ngim: Okay. So that is on your point on taking credit risk. But current high-grade corporates are just not cheap. In fact, credit spreads are trading at some of the tightest levels since 2005. So what are your views on these, and what would be your outlook for credit spreads then?
Dario?
Dario Messi: Yeah. I mean, from my side, it's true. I mean, most, if not all, spread products are not cheap from a historical perspective at least. But, yeah, you always need to ask yourself also if there is a reason for that. And I think there are some.
So if you look at default rates, they're coming down. And don't forget, we just had two default cycle also behind us. Fundamentals are pretty stable. So if you ask about my outlook, I don't think we can get much tighter spreads from here. That's very difficult.
But I also don't see a catalyst for a big widening for the time being at least. And I would say on top of that, really, investor demand is healthy for credit. They just like the all in yield that you get there.
Jonathan Liang: I agree with Dario on that point on the fundamentals. Defaults are probably gonna remain quite low this year in 2025. Spreads are not on the cheap side, I would say. However, if we look across the credit spectrum and we take a look at, say, extended credit sectors like corporate hybrids or bank capital, there, we can find wider spreads than traditional corporate paper. So we think that there's an opportunity there.
And right now, earnings are still very healthy. So like Dario said, we're not expecting big widening in spreads. And if you look at it, things on a yield side, on a nominal yield side, corporate credit right now is trading at levels that we last saw just after the global financial crisis. So from a yield perspective, we think there's still an opportunity there.
Elaine Ngim: How about US Treasury views? Many investors, they feel that the success in fixed income hinges on getting the US Treasury views right. Do you think that is really the case, Dario?
Dario Messi: Well, if you measure your portfolio on a daily mark to market basis, well, then, yes, treasury yield moves make up for quite a bit here, especially now in this more volatile times for rates. And I guess having a perfect US Treasury yield forecast is super helpful, But, also, let's be nimble here. It's not easy to get the forecast right. So, for me, it's much more important to know how the US Treasury works in a portfolio context. So, to get a better understanding on what are the current risks out there and how the Treasury would work in different scenario.
I think that's the important bit and also something that you can look out for in the portfolio context. And here, maybe also to add what Jonathan said before on the duration exposure, I see the point in not getting too excited on duration at the moment. I totally agree here. But, again, if you think about the US Treasury, to get some hedges into portfolios in the case of when we are wrong and the economy is slowing much faster than we want to believe at the moment. I think for such scenario, it's still good to have some high-quality bonds which could reduce a bit the reinvestment risk here.
That's why, all in all, we might actually also opt for a more balanced duration approach here.
Jonathan Liang: I would agree with Dario saying that, you know, we don't wanna be getting too excited about duration at the moment. But in credit investing, the other thing that's really important is actually avoiding the blowups through security selection and research. Because in credit, unlike equities, you know, you get a stock right, you can make a lot of money potentially. But in credit, you get your yield and you get paid back your principal, and that's it. So it's very important in credit investing to avoid the downgrades, the maybe not just downgrade, but defaults.
And at the moment, we think that it is still better to focus on carry rather than try to make money on the duration side.
Elaine Ngim: That is good to know. Thank you, Jonathan. Now why don't we expand a little bit more on emerging market? Consensus suggest emerging market will struggle if the US dollar remains strong. Do you both agree?
Dario Messi: Yeah. I mean, typically, you would say it does. It's always difficult when the dollar strengthen and when US yields are higher. But for now, it showed already how resilient the segment is. And I think there are probably some different reasons why you have not just these sound fundamentals also in emerging market, but still quite limited net supply of new bonds as well.
So the technical support here, I think, is quite strong. And, yeah, also, emerging market corporates, very resilient, probably also much less affected by the currency mismatch. So, for me, there is still some appeal for emerging market hard currency, especially on the corporate side, even if you have a dollar that strengthened quite a bit specifically as of last year.
Jonathan Liang: And just to add to that, I think another concern on many investors' minds is the impact of tariffs on emerging market corporates. And we think that concern might be a little exaggerated because when we look at the universe of EM corporates under our research coverage, out of 600 of them, only 16 of them have more than a quarter of their revenue coming from the US. So we think that in addition to the sound corporate fundamentals, we think the top line is also not gonna be that affected by what's going on on the US side.
Elaine Ngim: So staying on your research universe, right, let's shift our focus to implementation strategies. In volatile bond markets, active management is essential, as we all know, for capturing mispricings and enhancing total return. Jonathan, could you expand on your firm's investment process? Are there any differentiating factors?
Jonathan Liang: Yes. We have a proprietary investment process that we call FQT, and that stands for fundamental research, quantitative valuations, and market technicals. And when we say market technicals, we don't mean, like, charting the two hundred day moving average, meeting the twenty day, whatever. What we mean is understanding coming supply and investor demand. So by combining all three of these factors, we have been able to generate pretty consistent returns in our portfolios.
In addition, our process is not just bottom up. It's also top down. So we form a macro view. We also form a sector thematic view. And then we populate it from a bottom-up perspective with our best ideas from a research analyst.
Elaine Ngim: Right. Could you also walk us through how the analysis is done and in particular sector picks?
Jonathan Liang: At a sector level, and when I say sector, I mean industry sector level, we take a look at the industry's dynamics. You know, how many players are there? Is it dominated by a few? Are there many competitors and it makes competing very hard? Are they competing on cost, or are they competing on some kind of advantage in their business?
So from a high level, we then look at all these different industries, and then we can also take a look at where the spreads are in these different industries. And then we would then form our sector thematic view, and then we would then follow-up with the bottom-up bond by bond security selection to populate the portfolio.
Elaine Ngim: Do you think JP Morgan has an edge over the other pure play names when investing in distressed debts?
Jonathan Liang: Yes. JP Morgan, because of our sheer scale, we are often part of the major bondholder restructuring committees. So we have a seat at the table whenever something becomes distressed, and so we can work with the other major bondholders to work out an outcome that is best for us. And in fact, we have specialists within our credit research team that just does distressed credit investing. Some of them tend to have a legal background so that he can work out for us how to maximize the recovery value in the courts.
Elaine Ngim: So one of the main questions we often ask, by our investors as well, is managing volatility. So how do you lower volatility to achieve a better risk-adjusted return?
Jonathan Liang: When we manage volatility in our credit strategies, we use credit derivatives to either express a negative view on an individual credit, or we can use CDX index swaps that can help us generally lower the beta of the portfolio at any given time if we expect a period of volatility coming. Beyond that, we also use interest rate futures to manage duration risk or interest rate sensitivity. So if we think that treasury yields are going to rise in the coming quarters, we could take out temporarily shorts on the treasury side to help reduce our interest rate sensitivity.
Elaine Ngim: I remember how buying protection has failed as a hedge for me at least many years ago. In 2008, I think it taught us all a rather valuable lesson where counterparty risk was not taken into account. Has CDS evolved since then?
Jonathan Liang: Yes. I remember those days as well when CDSs were not centrally cleared. They weren't traded on exchanges. But, after the financial crisis in 2008, the regulators got smart about it and made sure that CDS are now all centrally cleared in exchanges, well -capitalized exchanges. And so counterparty risk is something that we have to worry much less about today.
Elaine Ngim: Staying on the fixed income strategies, including those managed by JP Morgan, they have been subjected to some form of volatility and drawdowns like those in 2020 where we have seen some of your flexible income strategy having some drawdowns to the low teens. Were there any learnings or takeaways you get from that?
Jonathan Liang: So volatility is unfortunately a part of everyday investing life, and all we can do is to try to limit the drawdown when volatility hits. And as I mentioned earlier, we have various hedging strategies that can do that. So while we had some, I would say, reasonable drawdown, certainly much less than the market, the lesson learned there is that derivatives and staying liquid and being able to take advantage of opportunities when volatility hits is really the key takeaway there. So we will continue to do that. So we won't be able to avoid volatility completely, but we will likely have much less volatility than the market in our strategies.
Elaine Ngim: Thank you, Jonathan. Now let's bounce back to both of you. What are the common misconceptions about investing in credit? Dario?
Dario Messi: Well, talking about liquidity, I think the fact that you can pick up assets at a nice price, for example, during a pandemic, is also just because others have to sell, and the bond market was not too liquid at some points there. So in other words, I think credit markets are not always very liquid, and especially not when you go down the quality spectrum and especially when everyone needs liquidity. And I think this is something that not every investor has in mind. Another misconception, I think, is always the process of default itself. This normally doesn't happen overnight.
The price of a bond, discounts quickly. The news flow, yes, but the default or restructuring process can take years until investors really get the recovery value back again. And this needs some serious work from specialized credit managers.
Jonathan Liang: And I would agree with Dario, but just add, you know, sometimes you hear downgrades or defaults. They sometimes can represent opportunities because if the market reacts to the incidence of a default, but then the actual ultimate recovery value is higher than where the bonds are trading at, you could actually still profit in a default situation, in a distressed situation. In addition, downgrade sometimes also present opportunities, for example, crossovers when they go from Triple B down to non-investment grade Double B. If you buy those bonds at the right time, they so called fallen angels, they have tended to outperform the investment grade universe by quite a big, big amount. So we think that default downgrades could sometimes present opportunities as well.
Elaine Ngim: Absolutely. Finally, what's your one key message to our equity loving investors?
Dario Messi: Well, from my side, I mean, look, we have good all in yields, good carry. I think there is certainly a good value proposition by itself already in credit markets these days. And I think also don't forget the diversification potential. I think if things really turn sour at some point, you will get a nice mark to market gain with a better quality bond specifically, just given the current starting point of yields. And this is exactly when you can use these gains then also to redeploy into maybe a bit less richly priced equities again.
Jonathan Liang: And from my end, I think in an uncertain environment, I think we can all agree that we are in a highly uncertain environment that carry is probably the most prudent option among investment strategies. So just staying in a high quality, well diversified portfolio and clipping 6% plus coupons, we think it's not such a bad idea in today's environment.
Elaine Ngim: Thank you both. Thank you, Dario and Jonathan. It was great to have you to share your thoughts and your valuable insights. Now to summarize, the bond market has already witnessed some remarkable swings this year and is pointing to another eventful ride ahead. Corporate credit presents opportunities for capital return, but management skill and credit selections are critical.
To mitigate all the risks and to capitalize on any market dislocations, having specialists on your side can make a significant difference in achieving investment success in this area. Thank you everyone for tuning in, and goodbye.
Outro: You have been listening to Beyond Markets by Julius Baer. If you like what you've heard, please tell us by leaving a review and rating on Apple Podcasts or Spotify. Subscribe to Beyond Markets on your favorite podcast player to stay up to date with our latest episodes. To learn more about Julius Baer, our people, our latest thinking, visit us at www.juliusbaer.com. We will be back with a brand-new episode soon. The information and opinions expressed in this podcast constitutes marketing material and are not the result of independent financial or investment research. Please refer to www.juliusbaer.com/legal/podcast for further important legal information