Still a window of opportunity for investing in target-date funds

After the success of previous vintages, Rothschild & Co Asset Management is launching two new high yield⁽¹⁾ and investment grade⁽²⁾ target-date funds. Three questions for Emmanuel Petit and Kristell Agaesse.

What is your take on the macroeconomic environment and the fixed-income markets?

After a phase of great instability on the fixed-income markets, the monetary tightening cycle appears to be coming to an end. At one time, we may have feared that this cycle would derail the economy, but the resilience we have seen has been a positive surprise on the whole. That being said, there are still some uncertainties on the outlook for how the economy will “land”, and we do believe that a hard landing⁽³⁾ scenario is likely, as financing conditions are clearly hawkish. Refinancing rates and key rates are likely to remain high for some time to come, and that will probably begin to weigh on the economy. Leading indicators are already pointing in that direction. Meanwhile, the deflationary cycle is already well underway in the US. However, it will be hard to stick to the hawkish stance if the economic environment remains resilient. In any case, it is noteworthy that visibility on monetary policies and the level of interest rates is now better than it was a year ago. Meanwhile, trends in risk premiums do not point to a significant worsening in refinancing conditions. Corporate default rates have risen and could very well continue to do so in the coming quarters. Toughening financing conditions, along with narrower margins, will no doubt undermine issuer solvency.

Why is this the right time for launching target-date funds?

The current investment window looks like an especially good time for launching target-date funds. The tightening cycle appears to have peaked, and the economy increasingly looks headed for a slowdown, but this is an attractive entry point for buy & hold strategies⁽⁴⁾ in order to tap into carry on bonds offering yields not seen since 2011. This is the case of high yield, in particular. The average coupon has risen to a point where it now properly remunerates the risk assumed. Moreover, the asset class possesses a strong capacity to handle defaults. The market environment also makes investment grade issuer yields attractive once again. Investment grade is a way to remain relatively conservative and avoid the excess volatility that a recessionary cycle could trigger. Government bonds yields also offer a “cushion” that offsets the rise in risk premiums. Moreover, there is little probability of default by investment grade issuers on a five-year horizon. The large size of the pool of issuers with sound fundamentals makes quality bond picking⁽⁵⁾ possible. It is against this backdrop that we have launched two strategies that are “pure” in the sense that they exclude perpetual bonds. One of these is exclusively investment grade, R-co Target 2029 IG, and the other is 100% high yield, R-co Target 2027 HY.

How does this type of strategy stand out in the current environment?

Since the September 2022 launch of our previous generation of target-date funds, in September 2022, rates have risen by 120 basis points and risk premiums have narrowed slightly⁽⁶⁾. Since then, the corporate investment grade market has returned 0.41%⁽⁷⁾ vs. 3.97% by R-co Target 2028 IG⁽⁸⁾. Thanks to our bond picking, we have been able to generate alpha⁽⁹⁾ on a steady basis, which illustrates our know-how on this type of strategy. This is something that ETFs, for example, cannot accomplish. Moreover, with its carry strategy and at current yields, a fund like R-co Target 2029 IG is an attractive alternative to euro funds. R-co Target 2027 HY, meanwhile, may be worth considering for an investor wanting equity exposure but who is scared off by the current economic cycle. Such an investor may be drawn to the visibility that this bond segment offers over a five-year timeframe. Moreover, while money-market yields may currently look attractive, investors have no visibility on their outlook for the coming years or even months. A target-date fund, in contrast, offers the advantage of “setting” a yield over a defined period. Moreover, these strategies are quite liquid and allow subscribers to exit whenever they choose. It is for all of these benefits that we believe these strategies make sense, especially in the current market environment.

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