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Fixed income Evolving investor trends

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Page 1: Fixed income

Fixed incomeEvolving investor trends

Page 2: Fixed income

Investing in an era of change can be daunting – but there are clear paths to positive outcomes

How four drivers of change are transforming fixed income investing

Page 3: Fixed income

While Covid-19 fuelled volatility proved relatively short-lived thanks in large part to government and central bank stimulus packages, those same policy responses, particularly the ramping up of quantitative easing (QE), both after the Great Recession and in the wake of the pandemic, had the effect of compressing yields. That, in turn, led investors to switch their attention to riskier frontier and emerging markets in the hunt for higher returns than those offered by the major developed economies. “We’re starting to see increasing demand for data from areas like China, India and Latin America, where it can be slightly harder to gather information due to certain restrictions and idiosyncrasies,” says Dave Bull, Head of OTC Data, Data Strategy and Management at Refinitiv, the global financial data and analytics provider.

The rise of socially responsible, sustainable and environmental, social and governance (ESG)-focused investing, including green and social bonds, is also gathering pace. Over the years, sustainability has gone from buzzword to business reality across all product categories, with financial firms and investors in the frontline of the faltering transition to a low-carbon economy. During Q1 of 2021, sustainable finance bonds (or sustainability bonds), where the proceeds are deployed to both environment-related and social purposes, reached $287bn,2 double the issuance levels of the same quarter a year earlier. Meanwhile green bonds, instruments specifically raised for climate and environment-related projects, quadrupled to $131bn – an all-time high – over the same timeframe.

Furthermore, sustainable fund assets under management (AUM) –encompassing everything from how individual companies deal with climate change or diversity & inclusion to how nations are tackling big picture climate-related challenges – reached a record of nearly $1.7tn3 in Q4 2020, a rise of 29% on the preceding quarter. “We don’t generally have customer conversations today without talking about sustainable finance,” says Bull. “It has become almost a given.”

Another key trend reshaping the fixed income space is around disruptive technology and analytics. Transformative technology, leveraging the cloud, is enabling investors to access more complex analytics tools, often over larger portfolios or datasets. This allows for real-time business insights, data-driven decision-making, and more advanced investment strategies – where different scenarios can be stress-tested – while also meeting regulatory requirements.

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IntroductionThe global fixed income market saw sharp growth over 2020, with issuance surging by 19.9% to $27.3tn, and global bond markets’ outstanding value increasing by 16.5% to $123tn.1 Yet despite this rapid expansion, the segment as a whole – which ranges from sovereign and corporate bonds to asset- and mortgage-backed securities – has been buffeted by waves of change, including pandemic-related volatility, the rise of emerging markets, a fast-approaching tipping-point for sustainable finance and tech-driven transformation.

1 www.sifma.org2 www.refinitiv.com3 www.reuters.com

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“Fixed income data is vast, complex and non-standard, but with the advent of data science, people are able to do so much more with it,” explains Emily Prince, CEO of Yield Book, the leading fixed income analytics system, and Group Director/Head of Fixed Income Analytics at the LSEG (London Stock Exchange Group), which acquired Refinitiv4 in January 2021. “A lot of these tools are enabling far deeper insights which also give investors much more confidence from a risk management perspective.”

Against that ever-evolving and complex backdrop, this report explores the challenges and opportunities for investors across three pivotal areas of fixed income: emerging markets, sustainable finance & ESG, and passive investing.

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4 www.lseg.com

Data science can back up investment insights in a number of emerging markets

The quest for yield –emerging & frontier marketsAs bond yields in the major economies have flatlined, so investors are increasingly seeking out higher returns in emerging markets (EM). Once seen as risky and volatile, emerging market bonds have in the past decade become a more mature and fast-growing segment of the global financial market. “If you look at EM in particular, over the past 20 years there’s been almost $40tn-worth of sovereign issuance alone, and almost three-quarters of that was since the financial crisis,” says Jon George, Global Head of Fixed Income, Currencies and Commodities (FICC) trading solutions at Refinitiv. “So the question, then, is why?”

George sees the impact of QE as “clearly a massive driver”, adding: “Come the end of 2020, the market value of negative-yielding bonds was at an all-time high, so that’s obviously been driven by QE, and from central bank corporate bond buy-backs in Europe and the US.”

Therefore Investors, looking to deliver alpha in incremental yields to their clients, are very likely to consider new asset classes. “You’ve seen accounts that had previously been more risk-averse looking at esoteric asset classes, such as structured credit, for example, but also they’ve been moving into duration and into riskier asset classes, such as emerging markets,” he says.

Investors, who hadn’t previously considered EM issuance, now have it firmly in their sights. And they tend to gravitate to sovereign debt, partly because it’s an easier asset class in EM to understand, but also because it plainly provides a more stable platform for EM exposure. “There is a high degree of sophistication required to buy into local currency corporate debt, because you need a fundamental view on, say, a locally based utility company, as well as the country view,” says George, “so that requires a level of on-the-ground intel that probably lends itself to only the most sophisticated of EM-centric investors.”

What, then, are the challenges investors should be aware of in EM? Whether clients are trading hard or local currency, transaction cost analysis [TCA] and pre-trade transparency are a genuine pain point, George expands. “When you’re getting into EM, if you’re building

Page 5: Fixed income

Jon GeorgeGlobal Head of Fixed Income,

Currencies and Commodities (FICC), Refinitiv

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up significant risk – say you’re loading up $50 or $100 million – the market could be trading in increments of two-by-two million. So, if you’re going to build a risk position in size, what is your TCA going to look like if you need to liquidate that?

“It’s one thing doing that in equities or even in FX, where you have lots of transparency, exchanges and data points. But because, by its nature, fixed income is a fragmented market, actually putting together the pieces of the puzzle is more complex. You need to go in with your eyes very wide open,” says George.

Part of that is having a strong fundamental country-bound view, which any EM house will have, he continues. “The biggest challenge is when you see market gyration. So, the retention of information – and the TCA component – is one of the biggest challenges that investors face in EM.”

Meeting the growing demand in EM requires greater depth of coverage of both local currency and broader issuance markets. Refinitiv provides industry-leading coverage for emerging markets OTC data, with over 1.2 million fixed income instruments in the EM space alone, sourced from over a thousand third-party contributors.

“There is a high degree of sophistication required to

buy into local currency corporate debt, because you need a fundamental

view on, say, a locally based utility company, as

well as the country view”

Refinitiv provides in-depth coverage of multiple global markets at a local level

“Pre-trade capabilities are key,” says George. “We already have ready-made buy-side solutions such as AlphaDesk, plus access to unique data sets from TradeWeb and MarketAxess, and some IDBs [Inter-Dealer Brokers] which we offer through our desktop and feed business as well, supporting transparency. We’ve also got huge coverage across emerging and frontier markets and significant degrees of local market knowledge and specialisation,” he adds.

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“As younger people are inheriting wealth, and

individuals become much more switched on to this

whole sustainability agenda, that’s creating change –

and it will move a lot more ”David Harris

Head of Sustainable Finance, LSEG

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Sustainable finance – The sleeping giants have woken up”The landmark IPCC report5 published in August 2021, described as “a code red for humanity” by the UN Secretary General, pushed the climate emergency and its catastrophic fallout to the top of the global news agenda. However, a shift to sustainable finance and ESG investing had already long been underway. Research from the Boston Consulting Group found6 that a growing number of large institutional investors are incorporating ESG metrics into their capital allocation and stewardship criteria, with asset managers “increasingly shifting from policies that seek to avoid risk by excluding specific securities, in favour of strategies aimed at benefiting from companies that perform better on Total Societal Impact (TSI) issues”.

According to the Global Sustainable Investment Alliance, as of 2018 $30.7tn was being professionally managed globally under responsible investment strategies, an increase of 34% in just two years. “The whole marketplace is going through a huge amount of disruption driven by sustainability and climate,” says David Harris, Head of Sustainable Finance at LSEG. “And this isn’t about creating bolt-on products, this is very fundamentally about how do we shift everything that we do?”

A growing number of sectors have already been upended by shifts in the global economy driven by the climate crisis, including mining, oil and gas, with utilities, aviation and autos also going through fundamental transformation. “There are a number of sectors which will be hit next,” says Harris. “We’ve already seen it with these sectors, but we will see it with cement, steel and chemicals as well. We’re also seeing, in parallel, the rise of new, green industries.”

A handful of major trends are currently shaping investor activity in the space, continues Harris. The first is around market demand shifts, with institutional investors becoming more sophisticated in what they want. “That’s partly also linked to them seeing themselves as universal owners and having a stake in the whole economy, where they are less interested in whether Company A outperforms Company B, and much more in being very long-term, sometimes even ‘intra-generational’ investors,

“There’s a huge amount of market disruption driven by sustainability and climate”

David HarrisHead of Sustainable Finance, LSEG

The environment is having a big impact on investments and markets

5 www.bbc.co.uk6 www.bcg.com

Page 8: Fixed income

now the US under Biden is moving, too, and we’re seeing massive changes going on in Asia as well – China is very switched on to the green finance agenda, although we see less of the S and the G side of ESG. But there’s a lot of movement globally from a regulatory standpoint,” says Harris who was a member of a select group of high-level experts convened by the European Commission to put together a report which became the basis of the EU Action Plan on Sustainable Finance.7

“The EU has been incredibly focused on driving this into regulation, based on our recommendations. We’ve now also got global regulatory influences like IOSCO, the International Organization of Securities Commissions, and IFRS, the International Financial Reporting Standards body, finally getting engaged as well, and helping achieve global standardisation, because the big risk is that different regulators in different countries will go off in a myriad of directions and actually create a mess. So we need these global players, and those moving fast like the EU and UK, to help with the standardisation.”

Then, there’s technology-driven change. The growing momentum in the transition to a sustainable low-carbon economy has, in turn, led to a tectonic technological shift encompassing everything from renewables to energy efficiency and storage, mobility, desalination and even flood defence systems. “We developed the FTSE Russell Green Revenues Classification System to define green industries, and it has 10 sectors, and 133 micro-sectors, defining products and services that provide environmental solutions. We’re looking at the level of revenue that’s derived from them, but it also gives you a basis to look at listed companies or the bonds that companies issue, and you can then start to measure the transition through the growth of these industries.”

Harris cites a number of products ranging from indexes to data and analytics that are essential for investors looking to navigate the sustainable investing maze. FTSE Russell, wholly owned by LSEG, launched the Climate WGBI8 – the Climate World Government Bond Index – which overweights and underweights companies in terms of their climate risk.

“We look at transition risk, physical risk and resiliency – which includes analysis of how proactive countries are being in taking action on climate change and getting ready for it, both in terms of

and how by shifting investment time horizons they can support more sustainable long-term orientated global economic growth.

“So, you’ve got that whole trend of the role of asset owners that has shifted – these sleeping giants have been waking up – and you’ve then got individual and retail investors who, up until now, haven’t been the main players driving this, but as younger people are inheriting wealth, and individuals become much more switched on to this whole agenda, that’s creating change as well. That’s an area which will move a lot more in future.”

Next comes regulatory upheaval. “Europe has been very active, but

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Investors need to be able to navigate the sustainable investments maze

7 ec.europa.eu8 www.ftserussell.com

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The slow-burn strategy of passive investing has seen a surge in popularity

climate mitigation, which is reducing emissions, and climate adaptation, which is getting ready for the physical impacts of climate change,” explains Harris.

Any notion that sustainability as an investment theme will somehow slip off the radar in time is fanciful. Rather the disruption across every industry, and indeed the global economy, will be on a par with the upheaval caused by the internet and mass-technology adoption. “Sustainable investing/ESG will absolutely continue to grow,” says Michael Contopoulos, Director of Fixed Income at Richard Bernstein Advisors in New York.

“More and more asset managers globally are putting emphasis on sustainability and sustainability-linked debt. Obviously, the greatest acceleration always happens early in a cycle, so we’re probably seeing the most rapid growth in the sustainability portion of the market today, and over the next several years. But in the short-term, that path is likely to accelerate further, particularly on the fixed income side.”

The shift to passive investing Passive investing – where investors follow a slow-burn strategy of buying and holding a diversified mix of assets, while minimising trades – has also witnessed explosive growth over the last decade-and-a-half. Research from Boston Consting Group found that assets held in passive funds soared from $3tn in 2003 to $14tn in 2018.9 With the global passive industry surpassing $15tn in assets for the first time in 2020,10 that trend looks set to continue.

Broadly speaking, the growth in passive investing – alongside multi-asset investing, which has shown a similarly sustained rise over the same period – reflects a wider shift away from traditional active funds. The passive approach enables investors to access a more expansive range of asset classes with relatively little friction and at a low cost. Increasingly, investors are constructing portfolios around risk, rather than asset class, amid growing consensus that a passive and/or multi-asset approach generates enhanced long-term returns.

A relentless driver in the shift to passive has been the boom in exchange traded funds (ETFs), which were on the cusp of outperforming traditional index-tracking mutual funds for the first time last year. Continued strong inflows so far in 2021 saw global AUM of passive index-tracking ETFs reach an all-time high of $8.66tn at the end of June – a fast-narrowing gap of just $132bn with global assets in passive mutual funds.11

In the pandemic-fuelled turbulence of the first half of 2020, flagship fixed income ETFs offered investors deep liquidity, continuous price transparency and lower transaction costs than were available in individual bonds, according to BlackRock, in what the global asset manager characterised as a “turning point” for fixed income ETFs.12 Moreover, the shift to passive has opened up a raft of new opportunities for investors, allowing them to invest across a range of fixed income securities that are bundled together by target themes such as sustainability, with ESG fixed income ETFs, or emerging markets ETFs.

Of the passive segment as a whole, Marina Mets, Head of Americas Fixed Income and Multi Asset Index Product Management, FTSE Russell, identifies three market-shaping trends. First is climate and

9 content.ftserussell.com10 www.ft.com 11 www.ft.com12 www.blackrock.com

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to climate alignment of below two degrees.” Next, Mets points to diversification of the type of markets that

investors are now able to track with the rise of new indexes – such as the FTSE Frontier Emerging Markets Government Bond Index Series13 – aligned to core investor preferences. “Emerging economies are looking at other sources of financing, and also looking to put themselves onto the global stage. And where they want to build up their fixed income issuance, and reserves, they are trying to do so in an aligned way so that global investors can take notice and track them. And indices are evolving to be able to provide that kind of information.”

Investors can also track the developed world government bond markets through a unique piece of work: the Country Classification Framework. Mets explains, “We look at a very transparent set of objective market criteria and engage with local market participants, as well as global investors. We look at market structure, FX, ability to transact, availability of debt, cash management programmes etc. It’s a very transparent framework, through which we assess and analyse where a market could be in that evolutionary cycle, and qualify these markets for entry into the various benchmarks that we track.”

The third key trend is the electronification of fixed income markets. Although electronification doesn’t relate exclusively to passive, of course, Mets states that the use of new technologies in the sector has certainly shaken things up and has allowed for much more sophistication as the market increases in complexity. “It’s brought a lot more speed and transparency into the fixed income market. It’s allowed for investors to have more access – and be able to make wider bets. It’s also allowed for much more sophistication and a lot more innovation in the type of products that have evolved,” she says.

Speed and transparency are shaking up markets – and spurring innovation

ESG, which she says has become a key driver in the development of passive fixed income strategies. “As part of our Sustainable Investment Fixed Income roadmap, we recently released a FTSE Green Impact Bond Index Series, which measures those securities that are specifically earmarked to use their proceeds for green projects relevant to clients looking at impact investing and engagement. Our flagship FTSE Climate World Government Bond Index and FTSE Advanced Climate World Government Bond Index is a tool that allows investors to measure the distance to get

13 www.ftserussell.com

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Moving into a data-driven futureIn a rapidly evolving and multifaceted market, with an often bewildering range of solutions available to choose from, having a single authoritative provider of fixed income data, services and capabilities has never been more crucial. The integration of LSEG and Refinitiv means investors, from the largest asset managers and pension funds to mid-size firms and individuals, can now access consistent pricing and reference data, as well as analytics capabilities.

“No matter the market trend, data is – and will remain – at the heart of fixed income,” says Dave Bull. “Being able to access timely, high-quality and accurate data, which is continually growing and evolving, across a single platform, as well having tools and capabilities to mine, manipulate and analyse it all, allows investors to effectively navigate these challenges and create opportunities that weren’t possible before.”

As for the overall fixed income market, Contopolous predicts further sustained growth. “Naturally fixed income is always expanding,” he says. “You always have new issuers, there are always new projects to fund, very few pay down their debt fully, so it’s a market that’s designed to expand over time and that’s certainly what I expect to continue.”

“No matter the market trend, data is – and will remain – at the heart of fixed income”

Dave BullHead of OTC Data, Data Strategy and Management, Refinitiv

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LSEG (London Stock Exchange Group) is more than a diversified global financial markets infrastructure and data business. We are dedicated, open-access partners with a commitment to excellence in delivering the services our customers expect from us. With extensive experience, deep knowledge and worldwide presence across financial markets, we enable businesses and economies around the world to fund innovation, manage risk and create jobs. It’s how we’ve contributed to supporting the financial stability and growth of communities and economies globally for more than 300 years.

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