For financial advisers and professional investors only – not for distribution to retail investors.
09 August 2024
Andrew Vonthethoff / Jason Argyris
An active investment approach is critical to navigate the disruption presented by generative AI.
Key points
- Generative AI presents potential opportunities and also potential risks for fixed income investments
- Understanding the advancements in this technology is key to avoiding downside risk
- An engaged and active approach to managing fixed income is critical
- Discover Macquarie Fixed Income
Generative artificial intelligence (GenAI) has the potential to profoundly reshape the global economy.
Leading technology firms are in a high-stakes arms race, investing hundreds of billions of dollars in a revolution that promises to supercharge productivity, transform industry, and stimulate global economic growth.
The result has been a stunning rally in equities markets as investors bet on the emergence of GenAI as an enduring theme driving investment in data centres, energy supply and infrastructure.
But for fixed income investors, the outlook is less clear.
While GenAI promises significant productivity gains, technological change also inevitably brings disruption, creating winners and losers across sectors and geographies.
So how can fixed income investors take stock of the potential for GenAI while avoiding possible downsides?
Investment in generative AI: the economic impact
The vast investment in GenAI is already having a macroeconomic influence, and has been one factor bolstering the resilience of the US economy, contributing to a persistence in inflation relative to other regions.
From a market perspective, a positive outlook for US growth has led to some underperformance in US government bonds, as bond performance tends to be inversely correlated with the outlook for an economy.
However, government bond markets are subject to multiple other macro-economic factors, as well as liquidity and supply/demand dynamics - meaning the direct impact on government bond yields is probably somewhat mixed.
In credit markets, however, strong growth and the buoyant equity market tend to be positive for credit quality – partly because rising stock prices reduce the pressure on management to seek market support through engaging in merger and acquisition (M&A) activity and taking on more risk to drive shareholder returns.
That means the GenAI tailwind has genuine potential to reduce credit risk across the economy.
Avoiding downside risk
Still, it is early days for GenAI – and as the technology matures the range of potential investment outcomes remains broad and unpredictable.
GenAI technology shows great promise, but its practical application is proving more challenging than many anticipated.
Early adopters are encountering significant hurdles in delivering on the promise of GenAI, with use cases often lagging the investment available, leaving room for potential disappointment.
At the same time, as the business community’s understanding of what GenAI can achieve accelerates and as early hurdles are overcome, GenAI has the potential for profound disruption.
We believe that fixed income investors must closely monitor the advancements in this technology, and the likelihood of these different scenarios as they unfold.
Companies that fail to deliver on lofty GenAI promises could be at risk of negative consequences on equity and credit valuations, while not properly evolving with the technology could risk disrupting business models across many sectors.
Signs of disruption are already potentially beginning to emerge in industry sectors like marketing, creative services, advertising, call centres, professional services, legal services and entertainment.
Many of the companies at risk of disruption from GenAI could also benefit if they successfully adapt and harness these new tools. Successful deployment promises growth and better margins as businesses build the capability to do more with the same number of people or maintain sales with fewer staff. This could potentially improve corporate fundamentals and reduce credit risk for investors.
As competition proliferates, the value of security and trustworthiness means incumbents that stay on top of the technology could benefit.
Fixed income’s stabilising role
So, how should fixed income investors think about GenAI?
We believe it is critical to acknowledge that GenAI brings both risks and opportunities (mentioned above) to a fixed income portfolio – and an active, engaged investment approach is needed to navigate the changes.
Interestingly, the tech companies at the forefront of the GenAI wave are not typically big drivers of fixed income returns because their high-quality bond issuances come with tight spreads and limited upside potential.
However, capital spending on energy, data centres, and other infrastructure will create opportunities for fixed income investors. For example, utilities are a large part of the fixed income investment universe and GenAI could become an important driver of demand, potentially improving earnings and providing an additional end market for the large volume of investment already being made into the electrical grid.
Successful fixed income investing is about stability of returns, consistent income generation, and downside protection. Each of these factors could be disrupted as the GenAI trend impacts both the economic environment as well as individual issuers.
Investors should acknowledge that fixed income plays a vital role in a diversified investment portfolio by acting as a stabilising force that can mitigate overall portfolio risk. With yields currently elevated, fixed income assets are providing additional stability of income, which can act as a more effective counter to the risk of an equity market downturn.
The important thing to remember is that transformational change brings both opportunities and threats – and we believe that taking an active approach that evaluates impacts sector by sector and company by company is critical to staying on top of changes as they happen.
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