How Should Investors Reallocate Their Portfolios for Year-End?

As we approach the year’s end, important developments in global markets suggest that investors may need to adjust their portfolios. Analysts at UBS emphasize the importance of a measured and strategic approach to portfolio reallocation during these uncertain times.

In the United States, credit investors have taken advantage of the opportunity to secure higher yields following a robust non-farm payroll report, resulting in U.S. credit spreads hitting their narrowest levels since May 2021. However, despite resilient economic data—reflected in stable consumer outlooks and better-than-expected growth—UBS warns that this environment allows for only a modest, rangebound outlook for credit spreads.

In Europe, while the recovery is progressing slower than anticipated, market technicals continue to support tight credit spreads. Focusing on carry strategies appears more promising in Europe, especially as breakeven rates remain elevated in the UK and Europe compared to the U.S.

European investment-grade bonds with maturities in the 5-7 year range currently provide attractive yields that strike a favorable balance between risk and return. In contrast, U.S. credit spreads are at their lowest in three years, diminishing their relative appeal compared to Europe.

For investors looking to optimize their portfolios, UBS suggests several reallocations. They recommend boosting exposure to U.S. high-yield bonds in the 3-5 year range while reducing exposure to investment-grade bonds in the same duration. Similarly, high-yield options in Europe within the 3-5 year range present an attractive opportunity for risk-adjusted returns.

Investors should also exercise caution regarding emerging markets credit. UBS advises decreasing exposure in this area, as risks in emerging markets are increasingly disconnected from trends in developed markets, especially in light of China’s post-COVID stimulus measures.

UBS highlights the value of carry, particularly in European and UK markets. GBP investment-grade bonds are identified as one of the most appealing options, providing solid diversification with low correlation to equity market performance.

The optimal zone for credit investments remains at the shorter end of the duration curve, with slightly longer tenors (5-7 years) also becoming competitive as they currently offer better yields than before.

Lastly, UBS analysts advise against increasing synthetic credit exposure, as cash bonds continue to deliver more attractive returns compared to credit default swaps.

As the year concludes, focusing on high-yield credit—especially in Europe and the UK—and shifting towards shorter duration credit instruments are key strategies to consider.