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November 16, 2021

A Solution in a Rising Rate and Inflationary Environment

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November 16, 2021

A Solution in a Rising Rate and Inflationary Environment


Insight Article

A Solution in a Rising Rate and Inflationary Environment

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November 16, 2021

 
 

The strong post-2020 economic recovery has led to a new era ruled by rising yields and higher inflation. Going forward, we believe it will be critical to invest in areas of fixed income that may be less impacted by rising rates. In our view, the Morgan Stanley Global Fixed Income Opportunities Fund is well-positioned for this environment.

 
 
  • The Fund’s unconstrained approach aims to decorrelate from the interest rate cycle to generate alpha—which is particularly beneficial in a rising rates environment. Due to its flexible mandate, the Fund is both able to help preserve capital and generate alpha by tactically reducing duration amid rising rates via active duration and curve management. Currently, the Fund currently has approximately 3 years of duration.

  • Our asset selection within the spread sectors, particularly higher yielding credits, should also help offset any further rise in rates. Within high yield, we continue to favor lower credit quality, primarily single Bs vs. BBs as high yield typically outperforms investment grade rated bonds in recovery periods. Given default rates have plunged, we believe allocating to lower quality bonds is beneficial for additional yield pick-up. Lower rated B rated bonds tend to outperform BBs if default risk continues to decline and investors reach for yield down the credit curve. Conversely, we believe avoiding low coupon, long duration BB credits should help mitigate the risk from a move higher in rates.
 
 
 
DISPLAY 1: Morgan Stanley Global Fixed Income Opportunities Fund: Portfolio Positioning
 

Subject to change daily. Fund information is provided for informational purposes only and should not be deemed as a recommendation to buy or sell any security or securities in the sectors and countries that may be presented. Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. See page 4 for the Portfolio’s standardized performance.

Source: MSIM, Bloomberg. As of September 30, 2021.

 
 
 
DISPLAY 2: Morgan Stanley Global Fixed Income Opportunities Fund: 5-Year Risk/Return
 

Source: Bloomberg, September 30, 2016 to September 30, 2021.

Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end Portfolio performance figures, please visit morganstanley.com/im or call 1-800-548-7786. Investment returns and principal value will fluctuate and fund shares, when redeemed, may be worth more or less than their original cost. See page 4 for the Portfolio’s standardized performance.

Global Aggregate represented by Bloomberg Global Aggregate Index (Unhedged), Global High Yield by Bloomberg Global High Yield Corporate Index, Global Investment Grade by Bloomberg Global Aggregate - Corporate Index, EM Debt by 1/3 J.P. Morgan Emerging Markets Bond Global Diversified Index; 1/3 J.P. Morgan GBI-EM Global Diversified Index; 1/3 J.P. Morgan CEMBI Broad Diversified Index. The indexes are provided for illustrative purposes only and are not meant to depict the performance of a specific investment. See Disclosure section for index definitions.

 
 

The Global Fixed Income Team’s Views on Inflation

The global economic recovery has been underwritten by expectations of continued fiscal and monetary policy support. Inflation has surged to multi-year highs, but most of this increase is expected to be transitory, and not something central banks have said they will respond to. However, there is a risk that they will change their mind, both because the inflation figures have been far stronger than expected, and because there is a risk that the inflation shock turns out to be more persistent than expected.

While inflation has continued to surprise to the upside, it is still our view that the surge is mainly transitory due to base effects, higher commodity prices, temporary bottlenecks in the economy and statistical issues. However, we expect the current high elevated inflation to continue, with year-over-year rates beginning to decline in 2H22. In the coming months, we also expect central banks to begin to slow or will have announced their intention to begin slowing asset purchases. Nevertheless, there is a risk that inflation is persistently higher going forward due to: 1) higher housing and accommodation costs, which tend to be sticky; 2) higher wages and labor costs, due to the economic scarring from COVID (lower participation rates); and 3) higher inflation expectations. Even if inflation, and inflation expectations, just return to 2010-15 levels, this should cause a significant repricing in fixed income markets.

Components of inflation like shelter/ accommodation costs and other prices that have historically been “sticky” (i.e., do not fluctuate much) have started to increase (Display 3). If price levels remain sticky, then this may drive wages higher that may create inflation risks longer term. Display 4 conveys that the average weekly earnings are rising, especially for lower-paid workers due to the shortages of workers (particularly in the services industries). In fact, data from the Federal Reserve Bank of Atlanta shows that median hourly wages for people in the bottom 25 percent of earners have risen at a 4.6 percent rate in the past year, compared to 2.8 percent for the top 25 percent.1 Furthermore, the Fed’s index of common inflation expectations (CIE) is now slightly above the 2 percent levels, after staying well below persistently prior to the recent surge in inflation risks (Display 5).

If the inflation shock persists, there is a risk that bond yields will start to rise. However, for now, the backdrop for the U.S. Treasury (UST) market remains sanguine. We believe for most of 2H21 we will see UST 10y yields in a range between 1.75% and 2.00%. We believe the surge in yields is likely behind us, with the peaks in growth, inflation and rate of fiscal spending seen in 1H21. Now, with the peaks likely behind us, the base effects for growth, inflation and fiscal spending will be harder to surpass and represent a de facto tightening of support programs and facilities. Additionally, tapering of asset purchases will begin in the U.S. in November, as expected.

 
 
 
DISPLAY 3: The inflation shock may not be transitory: U.S. shelter inflation
 

Source: MSIM, Bloomberg. As of October 31, 2021. U.S. Shelter based on component of Consumer Price Index (CPI). Please see Definitions on page 6 for full definition.

 
 
 
DISPLAY 4: U.S. average weekly earnings year-over-year
 

Source: Bloomberg. As of October 31, 2021. Based on U.S. Average Weekly Earnings Total YoY Index (USWEYOY Index)

 
 
 
DISPLAY 5: Federal Reserve Common Inflation Expectations indicator
 

Source: MSIM, Bloomberg. As of October 31, 2021. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass.

 
 
 
DISPLAY 6: Investment Performance - Class I (% net of fees)
 

Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end performance figures, please visit morganstanley.com/im or call 1-800-548-7786. Investment returns and principal value will fluctuate and fund shares, when redeemed, may be worth more or less than their original cost.

The gross expense ratio is 0.56% for Class I shares and the net expense ratio is 0.56%. Where the net expense ratio is lower than the gross expense ratio, certain fees have been waived and/or expenses reimbursed. These waivers and/or reimbursements will continue for at least one year from the date of the applicable fund’s current prospectus (unless otherwise noted in the applicable prospectus) or until such time as the fund’s Board of Trustees acts to discontinue all or a portion of such waivers and/or reimbursements. Absent such waivers and/or reimbursements, returns would have been lower. Expenses are based on the fund’s current prospectus. The minimum initial investment is $5,000,000 for Class I shares.

Returns are net of fees and assume the reinvestment of all dividends and income. Performance of other share classes will vary.

Blended Index performance shown is calculated using the Bloomberg Global Aggregate Index from inception through 12/31/2016 and the Bloomberg Global Aggregate Hedged USD Index thereafter.

 
 

1 Source: Federal Reserve Bank of Atlanta, as of August 2021.

 
 

Risk Considerations

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Mortgage and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Some U.S. government securities are not backed by the full faith and credit of the U.S., thus these issuers may not be able to meet their future payment obligations. High yield securities Investments in securities rated below investment grade present greater risk of loss to principal and interest than investment in higher-quality securities. Public bank loans are subject to liquidity risk and the credit risks of lower rated securities. Foreign securities are subject to currency, political, economic and market risks. The risk of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Collateralized mortgage obligations. Due to the possibility that prepayments will alter the cash flows on CMOs, it is not possible to determine in advance their final maturity date or average life. In addition, if the collateral securing the CMOs or any third party guarantees are insufficient to make payments, the strategy could sustain a loss.

 
 
 
The Global Fixed Income team follows a seamless process with a global outlook. They seek to identify and capture the potential value in situations where the market's implied forecasts are extreme.
 
 
 
 
 

DEFINITIONS

Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

Standard deviation shows how much variation or dispersion from the average exists. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.

The Bloomberg Global Aggregate Corporate Index is the corporate component of the Bloomberg Global Aggregate index, which provides a broad-based measure of the global investment-grade fixed income markets.

The JP Morgan CEMBI Broad Diversified Index is a global, liquid corporate emerging markets benchmark that tracks U.S.-denominated corporate bonds issued by emerging markets entities.

The JP Morgan GBI-EM Global Diversified Index is a market-capitalization weighted, liquid global benchmark for U.S.-dollar corporate emerging market bonds representing Asia, Latin America, Europe and the Middle East/Africa.

The JP Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets and is an expanded version of the EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans and eurobonds with an outstanding face value of at least $500 million.

Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto. “Bloomberg®” and the Bloomberg Index/Indices used are service marks of Bloomberg Finance L.P. and its affiliates, and have been licensed for use for certain purposes by Morgan Stanley Investment Management (MSIM). Bloomberg is not affiliated with MSIM, does not approve, endorse, review, or recommend any product, and does not guarantee the timeliness, accurateness, or completeness of any data or information relating to any product.

The views and opinions are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment teams at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific Morgan Stanley Investment Management product.

Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness.

This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Please consider the investment objective, risks, charges and expenses of the Fund carefully before investing. The prospectus contains this and other information about the Fund. To obtain a prospectus, download one at morganstanley.com/im or call 1-800-548-7786. Please read the prospectus carefully before investing.

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