After every sharp drawdown in fixed income, there have been strong recoveries. Though one must be careful not to discount the adjustment that bond markets have just lived through, we believe high-quality bonds have the potential to deliver the best risk-adjusted returns.
Faced with continued uncertainty and an abundance of risk, one may be tempted to time the market or wait for attractive entry levels. We believe this may be a mistake. In our view, it would be more prudent to focus on asset allocation and consider an increase in higher-quality fixed income sectors, including GCC bonds or global sukuk, that look poised to better defend portfolios and provide attractive levels of income.
WHAT ARE THE RISKS?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in lower-rated bonds include higher risk of default and loss of principal. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. In general, an investor is paid a higher yield to assume a greater degree of credit risk. The risks associated with higher-yielding, lower-rated debt securities include higher risk of default and loss of principal. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.
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1. The Gulf Cooperation Council (GCC) is a political and economic union of Arab states bordering the Persian Gulf. Established in 1981, its six members are the United Arab Emirates, Saudi Arabia, Qatar, Oman, Kuwait and Bahrain.
2. The Dow Jones Sukuk Total Return Index is designed to track the performance of global Islamic fixed income securities, known as sukuk. The index measures an investment (excluding reinvestment) in US dollar-denominated, investment-grade sukuk that have been screened for Shariah compliance. The JP Morgan EMBI Global Index measures total returns for traded foreign debt instruments in emerging countries. The FTSE MENA Broad Bond Index tracks GCC corporate and sovereign bonds. The Bloomberg Global High Yield Index measures the global high yield debt market, representing the US High Yield, the Pan-European High Yield, and Emerging Markets Hard Currency High Yield Indexes. The Bloomberg Global Aggregate Index measures global investment-grade debt from 28 local currency markets including treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. See www.franklintempletondatasources.com for additional data provider information.
3. Spreads are measured in basis points. The JP Morgan Middle East Composite Index (MECI) measures the performance of Middle East corporate and sovereign bonds. The J.P. Morgan Emerging Market Bond Index Global Diversified Index (EMBIGD) is a uniquely weighted USD-denominated emerging markets sovereign index. The Dow Jones Sukuk Total Return Index is designed to track the performance of global Islamic fixed income securities, known as sukuk. The index measures an investment (excluding reinvestment) in US dollar-denominated, investment-grade sukuk that have been screened for Shariah compliance. The J.P. Morgan Emerging Markets Bond Index Global (“EMBI Global”) tracks total returns for traded external debt instruments in emerging markets.
4. Source: IMF, COVID-19 Policy Tracker and staff calculations.
5. Source: Bloomberg, as of December 27, 2022.
6. Source: Bloomberg.
7 FOMC “Dot Plots” as of December 14, 2022, show a median of 5.125%, and a high of 5.625%. There is no assurance that any estimate, forecast or projection will be realized.
8. Sources: Bloomberg, Kamco Invest Research, GCC Fixed Income Market Update, December 2022.
9. Ibid.