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New Year’s resolution: when you buy government bonds in 2024, do it in a responsible manner

New Year’s resolution: when you buy government bonds in 2024, do it in a responsible manner
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ARTICLE TYPE
Insights
TOPIC
Responsible Investing
PUBLISHED
December 22,2023
READ TIME
4 mins
AUTHOR
Irina Kurochkina
SHARE
Back
ARTICLE TYPE Insights
TOPIC Responsible Investing
PUBLISHED December 22,2023
READ TIME 4 mins read
AUTHOR Irina Kurochkina
SHARE

Last week the US Fed surprised the market by indicating the start of a discussion on when to cut interest rates. For many investors, this was a signal they were waiting for: time to extend the duration of strategic fixed income allocation in anticipation of yields moving to a lower range. We believe investors should use this reallocation to enhance their sovereign exposure with sustainable investment features.

Comeback of government bonds

Extending duration in this stage of the cycle is quite a rational move, not only because of the idea of “locking in” higher yields, but also as a risk measure due to the deteriorating outlook for many European economies. While the GDP growth proved to be more resilient in 2023 than expected, the effects of tighter monetary policy are still spreading through the economy. Even if there is a “soft landing” with no severe recession, there is a high probability of a pickup in unemployment, a rise in default rates, and higher volatility in financial markets. The ECB staff is forecasting modest GDP growth of 0.8% for 2024, and they expect that next year corporate margins will shrink on the back of lower inflation and higher labor costs. With risks skewed to the downside, many investors might want to reduce overall risk in their portfolios and increase an allocation to safe-haven assets like government bonds. The fact that this asset class is the most liquid one is also very important in the new market environment where high volatility might force investors to trade faster to respond to market events or to generate cash to cover capital calls and collateral movements. With that backdrop, there is a strong case to have a substantial allocation to sovereign bonds.

Old good practices are not good enough

For some investors, it will be the first time in almost a decade to conclude that government bonds are attractive addition to the portfolios. Many things have changed in the last years, and investors now look beyond risk and return characteristic, with the shift to Responsible Investing (RI) impacting all asset classes, including sovereigns. Some investors disregard any RI efforts in their sovereign exposure as they think there is little that can be done, but this is an outdated view. In the past, the major characteristic defining the quality of a government bond issuer was its credit rating. It was seen as a stamp for a fair assessment of risk stemming from a certain country, so whether the government can pay back the debt and is willing to do so. With the increased scrutiny on institutional investors, sometimes driven by clients or the broader public, many investors started to exclude some countries from the investment universe not only based on credit ratings but also on violations of international norms and human rights. While this was an important development at the time, it proved to be not restrictive enough to safeguard investment results and prevent reputation damage.

ESG integration and beyond

We encourage investors to systematically integrate ESG considerations in their government bond allocations. Even for AAA/AA-rated countries or LDI portfolios, there should be a thoughtful process from the RI perspective not only to protect financial results but also to follow up on the RI commitments and meet regulatory requirements. For us, ESG integration1 is about the financial materiality of non-financial factors that play an important role as a risk management tool and a method to identify investment opportunities.

 

For those investors who want to step up beyond ESG integration to understand what their portfolio means for society and our planet, we support efforts in aligning portfolios towards sustainability themes and positive outcomes. For example, we assess all countries based on the UN Sustainable Development Goals to determine the strength of their commitments toward progress on social and environmental challenges. We built an investment strategy2 based on this approach, and we can also apply this research for different customized portfolios by focusing on those sustainable indicators that are relevant for a specific investor based on clients’ base or organizational values.

 

We believe that by enhancing sovereign exposure with sustainable features investors can improve their risk-adjusted returns, fulfill fiduciary and regulatory obligations, and contribute to positive social and environmental outcomes. The year 2024 might bring more turbulence with a slowing global economy, elevated market volatility, and geopolitical tensions, so while investors face many uncertainties, it is in their hands to allocate capital in a responsible manner.

 

 

1 Read more about our Responsible Investing framework on https://www.aegonam.com/en/responsible-investment

2 Explore our Sustainable Sovereign strategy on https://www.aegonam.com/en/strategies--funds/fixed-income/global-sustainable-sovereign-bond-fund/

Important Information

More about the authors

Irina Kurochkina Portfolio Manager

Irina Kurochkina is a portfolio manager in the fixed income, LDI and investment solutions team with a focus on sovereigns.

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