The asset class tipped to lead the charts in 2023

Could one of this year’s worst investments become next year’s best? Professional investors think so. 

Professional investors expect government bonds to be the best-performing asset of 2023, as interest rates peak and safe income payments become more valuable against a tough economic backdrop.

Bank of America’s fund manager survey for December, which quizzed investors with £650 billion under management between them, found that 27% said this would be the best asset class in 2023.

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This was followed by stocks (25%), corporate bonds (24%) and commodities (12%).

Allocation to bonds surged in December with respondents saying they were 10% overweight, which is the first time investors have been overweight bonds as a group since April 2009.

Retail investors have also been buying bonds, with funds trade body the Investment Association (IA) finding that Sterling Corporate Bonds was the best-selling investment sector in October, with inflows of £879 million.

In November, Calastone, a fund data group, found that the trend continued, with around £1 billion of inflows into fixed-income funds in the UK.

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Higher yields are tempting investors back into bonds, with prospects of interest rate cuts towards the end of next year to stimulate the economy also providing hope of capital gains.

With inflation forecast to fall next year, investors who are happy to look out a couple of years are able to bag a positive real income from lending money to established companies. Yields have risen over the past year, with the average yield to maturity on sterling corporate bonds now at around 5%, and US and UK government bonds yielding around 3%.

Investment grade corporate bonds could be a savvy bet in the event of a deep recession due to their income payments, which are usually reliable. These defensive characteristics could also lead to capital appreciation. Peak interest rates forecast for the first quarter of 2023 and the possibility of rate cuts later in the year are also tailwinds for the asset class.

Signs that inflation is cooling has already sparked a bond market rally over the past month (causing bond yields to fall and bond prices to rise), but investors are betting that there is more good news to come.

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Bank of America found that a record 90% think that global inflation will be lower within the next 12 months, and inflation in the US will fall to as low as 4.2% by the end of next year, from around 7% today.

Investors took down cash levels in December to 5.9%, from 6.2% in November, as risk sentiment started to ease.

Another bright spot was the outlook for the Chinese economy, which would have positive knock-on effects globally.

Bank of America found that investors' optimism on the China growth outlook surged in December, with 75% of investors now seeing a stronger Chinese economy in 2023 (up from net 13% in November).

This is the most positive outlook since May 2021. Moreover, most investors (74%) expect China to fully reopen by the end of 2023.