HSBC Global Private Banking and Wealth is shifting its focus towards quality across all asset classes amid the volatile market conditions expected to continue throughout the year.
The wealth manager is favouring investment grade over high yield bonds, with the number of defaults in the latter category expected to rise.
Global CIO Willem Sels (pictured) said that, with markets prone to ‘forward guessing’ on a range of factors including interest rate movements, investors should focus on structural trends to provide ‘a sense of direction’.
In the firm’s investment outlook for the second quarter of 2023, Sels said: “Markets have been twisting and turning since the start of the year, driven by a fall in inflation, the seemingly imminent end of Fed rate hikes, a faster-than-expected reopening in China and lower energy prices. Many of these factors will remain key throughout the next six months.
“The bad news for markets, however, is that the Fed is very unlikely to cut rates until Q2 2024, unless US growth slows more markedly than we anticipate, leaving us with a ‘higher for longer’ scenario.”
In response to this scenario, HSBC has shifted its bond duration.
“The continued fall in inflation and the fact we believe we are nearing the end of the Fed’s rate hiking cycle were key factors behind our decision to extend our bond duration from 3-5 year to 5-7 year maturities,” Sels continued.
“The longer rates stay high, the greater and more prolonged the stress on highly leveraged borrowers, as more and more loans need to be reset, and bonds need to be refinanced. This is a key reason why we look for quality in fixed income, preferring investment grade over high yield, as defaults in high yield are likely to rise from here.”
Equities weighting upgraded to neutral
Meanwhile, the firm has upped its weighting towards equities. While the firm’s portfolios are neutral overall towards developed markets, it is mild overweight in US and underweight in the United Kingdom.
It is also overweight in Asia following China’s long-awaited relaxation of Covid containment laws.
Sels said the firm is adopting a selective approach to act with conviction in regards to equities.
He said: “The ‘less bad than expected’ economic outlook for developed markets has led us to cover our underweight in developed markets equities and move our sector exposure from defensive to a more neutral positioning. Our largest overweight is in China, due to the faster-than-expected reopening there and the government’s clear shift towards a growth strategy. This should also benefit the West, but especially Europe, which is why we have narrowed the gap between our European and US exposure.
“Still, the broadly neutral allocation to developed markets equities signals that there are limits to our mild risk-on stance. This is because there is still scope for significant volatility and rotation in markets. Furthermore, the recent turmoil in the US banking and IT sectors has, of course, hit risk appetite. But it is also because fundamentals, positioning and valuations differ by market and region. Hence, we like to take a selective approach, focusing on those areas where we can have conviction.”
Opportunities in alternatives
Alternatives also present an opportunity to capitalise on the volatility currently impacting markets, according to Sels.
The firm is overweight in hedge funds, while keeping its core allocations to private markets and real estate.
He added: “As with equities and fixed income, a focus on quality is essential when it comes to alternatives. It is essential that investors keep core allocations restricted to private markets and real estate, while avoiding excessive leverage in real estate.
“Alternatives also provide an opportunity for some degree of gain to be made from the volatility currently afflicting markets. A rise in defaults in high yield and emerging markets should lead to distressed opportunities, and we think that investors in private markets will find that the 2023 vintage should benefit from good entry points.”
See also: Fixed income dominates Evelyn Partners MPS rebalance
