„In the field of sustainable bonds, quite a lot has happened in the last 5 to 8 years”

Maria Municchi is Italian, moved to the UK for studying, and stayed. Most of her career she was with M&G, where she started on the equity side and then looked at convertible bonds, before becoming an investment specialist. Now she is a portfolio manager for multi asset strategies with a sustainability focus. We talk with her about her market views. In another interview we talked with her about mixed teams and why they provide better outputs.

Maria, since summer 2024, we can see quite some market volatility and some sell-offs. Do you think that this is just an episode or the start of a longer downward trend? How do you assess this from a behavioural finance perspective?
It is too early to say that this is the start of a longer downward trend, particularly as recent data in the US still points to a strong economy. However, we can observe expensive valuations in the US and clear evidence of investor complacency which has led to a crowding of beliefs that “US exceptionalism” can continue into 2025. To us, this represents a reason to be cautious, as a strong consensus view is vulnerable to reversal, and as such we prefer more attractively-priced areas of the market.

It is also important to highlight that market volatility, particularly when triggered by investor emotion, provides us with useful short-term tactical opportunities to exploit. The upcoming Trump administration adds another layer of uncertainty and reinforces our strategy of maintaining a diversified portfolio while being prepared to respond to market overreactions.

How did you react in your funds?
We increased duration in both, the US and UK, given attractive real yields and the potential for diversification in the event of a growth shock.

We closed our HY credit exposure, given tight spreads and limited compensation for the additional risk, particularly if a growth shock does materialise and we see an unwinding of the consensus view outlined in the previous question.

How about the other markets, apart from the US?
US equities have continued to become more expensive in 2024. We therefore prefer non-US equities which are more attractively priced and we added to UK equities in October.

The divergence between US equities and the rest of the world has continued to widen following the US election result, which has led to a continuation in outperformance of US equities. This appears to be more of a reflection of enthusiasm for the incoming Trump administration and the expectation of higher nominal growth rather than a consideration of the underlying corporate reality.

What are you doing on the equity side?
We are neutral on equities, given ongoing economic resilience, but are cognisant of valuation headwinds and elevated real interest rates. We prefer attractively priced assets and therefore have a bias towards non-US equities.

In particular, we believe there are still attractively valued opportunities in Asian and Latin American equities, as well as specific pockets within developed markets, such as European banks and UK stocks. As mentioned in a previous question, we added to UK equities in October.

We have also updated our US, Asian and Japanese equity baskets to reduce tracking error with their respective indices, while maintaining our positive impact exposure and incorportating the views of M&G equity analysts where possible.

How do you currently view China (from a tactical perspective)?
We added to Chinese equities in January 2024, when we saw attractive prices. At that time, there was a general view that it was unnecessary for investors to be invested in China. The fundamentals were recognized as weak, but they are improving. And then, in April / May 2024, we have seen a significant rally, which we used as an opportunity to exit and realise profits. So the China-exposure has been taken off by us.

How are you dealing with your bond exposures? Are you currently increasing duration, given that interest rates may soon fall again?
We still like long-dated US Treasuries as an attractively priced form of portfolio insurance and have switched some exposure further along the curve into US 30y Treasuries. Long-dated UK gilts also look attractive, given declining levels of inflation while the Bank of England base rate remains elevated. We therefore added to 10y green gilts when the market was worrying about the fiscal element which put some pressure on yields as well as a bit of cyclicality which we have observed has caused yields to move higher around the time of the UK budget in recent years.

We retain positions in a well-diversified basket of emerging market government bonds in local currency which we consider to be an attractive source of medium-term returns. We are particularly looking at Brazil and Mexico with the potential to add.

We don’t see value in corporate bonds given the current level of credit spread and its recent compression and have closed our high yield credit exposure.

How about listed infrastructure, will the tide possibly turn here?
Listed infrastructure has been a challenging area for us this year. From a fundamental perspective, the increase in interest rates, together with low European gas prices have had a negative impact on these businesses. However, we have seen companies being very reactive to this new environment, for example by doing shares’ buybacks or recycling capital to acquire new assets. Being flexible is important. We have continued to engage with the companies in which we invest and believe they are doing the right things, therefore we will expect some turn arounds, especially given the current discounts to NAV. We continue to see them as good value. They are paying dividends and from a sustainability standpoint, they continue to deliver a very interesting outcome from a renewable energy production standpoint.

How do you currently view valuations (in all asset classes)?
Valuations currently look very stretched in US vs Europe. When adjusting the sector component to equate US weights, the divergence isn’t quite as large but European valuations are still more attractive. Despite this, Europe has materially underperformed US in the latest phase with the rolling performance differential touching levels we have rarely seen, so there is clearly a structural difference, but recent price action and investor sentiment – which is increasingly turning bearish – suggests the potential for increased upside in Europe vs US.

As mentioned, we see attractive value in long-dated government bonds given positive real yields and inflation trends, which remain well-behaved across most major developed markets. Long-dated government bonds therefore appear to be a very attractively priced form of portfolio insurance.

How about the tech companies?
While concentration at the index level remains a concern, the resilience and superb long-term track record of earnings growth from Big Tech could potentially mitigate some of these worries.

How can you invest sustainably in a multi-asset portfolio?
At M&G, we have a strong due diligence, and we believe our standards are robust. In our multi asset funds our approach is twofold: a) Impact investing, where we can measure our impact, and b) Sustainability, which include amongst other things a focus on carbon emission and emission reduction targets the companies have in place.

Is that approach the same for equities and for bonds?
For equity investments, the standards are more evolved. In the field of sustainable bonds, quite a lot has happened in the last 5 to 8 years. We now have much more sustainability information in the field of fixed interest investments. Green bonds have been around for a while, but the standards are much higher now, and the reporting has improved as well. This gives investors a much better way to invest in sustainable solutions within the bond market.

Which kind of sustainable fixed interest investments do you prefer?
For us, from both, a sustainable and portfolio construction standpoint. One of the most interesting areas in fixed income are development bank bonds, where we can achieve a diversified financial exposure while ensuring high standards of sustainability.

ESG investments underperformed in 2023 and 2024. Is a trend reversal in sight?
It has been a challenging time. In our funds, we like having exposure to renewable energy stocks, which have had a difficult time during all of 2024. Despite the recent headwinds, including elevated interest rates as well as supply chain issues, I believe that from 2025 we might be able to see better earnings and developments in the renewable energy space, and at current valuations these stocks might represent a good opportunity for investors with a longer term horizon.

Thank you for these interesting market insights, Maria!