Quantitative un-easiness

07/03/2019

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Nick Maroutsos, Co-Head of Global Bonds, explains why bonds offer potentially attractive qualities for income-focused investors worried about rising equity market volatility.

Perhaps simply ‘queasiness’ is more fitting. Certainly that is an apt feeling among investors who stomached sharp falls in risk asset prices in the last quarter of 2018, again bringing into sharp focus the question of asset allocation as investors consider the path ahead.

While some of the falls have reversed in early 2019, it is important to consider what may have driven the sharp declines and question whether they are symptomatic of a more prolonged malaise or a temporary setback. While this is impossible to answer with certainty it is hard to ignore the secular shift in the comparable risk/reward metrics of major asset groups, driven by changes in macroeconomic dynamics and an ever fluid political backdrop.

Equity markets have barely missed a beat while rewarding investors for much of the post-Global Financial Crisis environment, buoyed by central bank monetary stimulus. The combination of a stable tiller and cheap money is an intoxicating mix. But now, perhaps if the initial US experience is anything to go by, we are seeing for the first time in a long while the impact of having ‘the training wheels off’, of borrowing costs moving back to a more normalised level, on a jittery equity market.

What we are faced with today is a shifting set of relative market dynamics combined with a much less certain political landscape, with neither being ‘equity friendly’.

One thing that is arguably different in 2019 is the risk premium or simply the forecast return spread between cash and bonds, and equities. The sub 1% cash rate environment of the past decade was utopia for equities: dividend yields of 3-4% easily making them the darling of any asset allocator’s tool kit. But now that cash rates in the US have exceeded 2% the cost of doing business has changed markedly and the equity dividend yield return spread is less attractive. And that is before we factor in the higher sovereign and credit yields. Sure, there can be some pain to wear on the way up if duration exposure is left unhedged, but the forward-looking potential returns from fixed income asset classes today look a whole lot more appealing, with US 10-year Treasuries above 2.5%, and US investment grade credit yields comfortably above 4% at the medium-to-long end of the curve*. Suddenly an equity dividend yield of 3-4% doesn’t feel quite as rich. And almost certainly not on a risk- or volatility-adjusted basis.

Within Europe, the yield on European investment grade is not as generous as the US at an absolute level but when set against negative rates and low yields on Europe’s equivalent of the US Treasury – the German bund – there is a pickup to be had. Here, selectivity can offer incremental income without assuming excessive default risk. 

Yield curve on investment grade and sovereign bonds in Europe
C1
Source: Bloomberg, Bloomberg Europe Corporate Investment Grade BVAL yield curve, Bloomberg Germany Govt Bills and Bonds BVAL yield curve, 28 February 2019. Yield shown is yield to maturity.

What is more, given the global economic slowdown and the US Federal Reserve shifting its rhetoric on monetary policy, openly discussing the possibility of pausing its balance sheet reduction, it is hard to see the European Central Bank embarking on quantitative tightening in the near term.  For now, therefore, we must work within the confines of a low yield environment. 
The low yields are symptomatic of a fragile economic backdrop. After all the noise of 2018, it concluded with those carrying the most defensive strategic asset allocations victorious, and serving as a worthy reminder that through cycles there will always be periods where it pays to bias your objectives towards not losing money just as much as making more.

Risk was not rewarded in 2018 for investors in European assets
 
C2

Source: Thomson Reuters Datastream, 31 December 2017 to 31 December 2018, MSCI Europe, ICE BofAML European Currency High Yield, ICE BofAML Euro Corporate, ICE BofAML EU Government, total return indices in euro. 
Past performance is not a guide to future performance

Regardless of whether risk asset volatility of the past few months proves to be temporary, or more sustained, we anticipate a harder environment for equities to maintain the strong competitive edge that they have enjoyed over the past decade. The economic backdrop has developed into one where optimal balancing between prudent defence and sensible return-seeking becomes paramount – looking to capture returns potential while seeking to insulate against observable and uncertain risks. In a practical sense, this could mean extending duration in countries that are a long way from raising interest rates, such as Australia.
The likelihood is that this remains an environment where a strong constitution is important. Take a few deep breaths, and to borrow from the singer Nat King Cole, while there may be trouble ahead, we must face the music and dance. But perhaps from a safer point on the dance floor, with the exit within sight.
 
*Source: Yields as at 28 February 2019, Thomson Reuters Datastream Benchmark US 10-year government bond yield to maturity, Bloomberg US Investment Grade BVAL yields.
 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

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Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • This fund is designed to be used only as one component of several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Absolute Return Income Fund (EUR)

For institutional/ sophisticated investors / accredited investors qualified distributors use only.

All content in this document is for information or general use only and is not specific to any individual client requirements. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation or investment advice, nor should be taken as a basis to take (or stop taking) any decision.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying agents, it should be read carefully. An investment in the fund may not be suitable for all investors and is not available to all investors in all jurisdictions; it is not available to US persons.  Past performance is not indicative of future results. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements.  Shares, if redeemed, may be worth more or less than their original cost.

Janus Henderson Group plc and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regards to the results obtained from its use. As with all investments, there are inherent risks that each individual should address.

The distribution of this document or the information contained in it may be restricted by law and may not be used in any jurisdiction or any circumstances in which its use would be unlawful.

Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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