Fixed Income
Fixed income markets experienced a return to relative stability in 2021, as government stimulus policies ran their course and global economies began to reopen and recover. The only notable outliers were emerging markets, which underperformed due to inflation concerns, U.S. dollar strength, and rising core yields.
While the pandemic still dominated, vaccine developments and deployments helped governments to reopen their economies and keep them largely operating even as new variants emerged. Nominal growth in advanced economies rebounded strongly in response to additional fiscal stimulus and continued pledges from major central banks to support their economies. This backdrop saw core rates initially sold off in a bear-steepening fashion while the U.S. dollar stayed firm throughout.
As the year progressed, headline and core inflation measures, as well as medium-term inflation expectations, rose significantly on increased demand, supply bottlenecks, and sharply higher commodity prices. While central banks sought to see beyond transitory factors, inflation dynamics proved to be more persistent than initially anticipated. This prompted them to revise their forward guidance and begin the process of tapering asset purchases and hiking rates, earlier and faster than previously communicated.
Against this backdrop, the story in credit markets was one of resilience and falling dispersion between ratings, sectors, and single names. Investment grade spreads were largely unchanged at the index level, with high yield spreads moving tighter and delivering the strongest performance. Only the arrival of the Omicron variant at the end of November injected some volatility into the market, by adding to existing fears about higher inflation.
Emerging markets were a key outlier, despite strong growth and solid terms of trades. Many central banks in the LATAM and CEEMEA regions hiked rates aggressively to curb rising prices and inflation expectations. In parallel, emerging markets generally, and Southeast Asia in particular, responded more negatively than elsewhere to surges of COVID variants.
In China, meanwhile, other non-pandemic-related factors had an outsized impact on the economic cycle, with relatively tight policies and deleveraging in the real estate sector weighing on economic growth. Growth expectations only began to improve toward the end of 2021, as authorities signalled a more pro-growth policy stance.
In 2021, ADIA’s Fixed Income Department continued to focus on increasing internal flexibility and alpha generation. To this end, the Department’s core portfolio support activities, including beta replication, trading, liquidity and funding, were transferred into ADIA’s newly-created Core Portfolio Department. In addition, its middle office activities were transferred to the Central Investment Services Department. As a result of these changes, the Fixed Income Department is now focused entirely on generating alpha.
In addition, the department funded a number of Global Aggregate managers during the course of 2021.
In 2022, the department will continue to build out its quantitative research capabilities to enhance investment decision-making and broaden its alpha generation activities. It will also seek to deploy further capital into less liquid areas of fixed income including private credit, in order to enhance returns in the low yield environment.
