Coronavirus update from the Strategic Fixed Income Team
The spread of the coronavirus across the globe and the oil price war have served to highlight the fragility of the global markets and rattled investors. As concerns for the global supply chains and the health of economies grow, Jenna Barnard, Co Head of the Strategic Fixed Income Team, shares her views, explaining the steps taken in the team’s portfolios that seek to mitigate the risks.
- Our credit style of ‘sensible income’, essentially a quality filter, has served to underpin the credit exposure in our portfolios in recent weeks.
- Our general view is that the coronavirus incident provides an opportunity to selectively add risk, given our relatively defensive strategic asset allocation.
- We view the recent market moves as the culmination of a decade-long regime in which quality outperforms value, driven by a lack of structural growth, ESG and now compounded by a cyclical global collapse.
A sensible income strategy
Our credit investment style of ‘sensible income’, essentially a quality filter, has served to underpin the credit exposure in our portfolios during the coronavirus incident. We hold no commodity bonds, no Italian or emerging market corporates, no airlines and no autos. What the filter does not do is protect us against generic spread widening in the corporate bond market, which has been significant. Monday (9 March) was one of the largest days of spread widening on record.
For example, taking the case of the global high yield (HY) market, there are over a trillion dollars of bonds in the index, which we would not consider for investment.
Chart 1: our credit screening methodology
Source: Janus Henderson Investors, February 2020
Note: OEMs = original equipment manufacturers
Coming into this incident, our credit asset allocation was the most defensive it has been in our 16 years of running strategic portfolios (as proxied by the high yield exposure in the asset allocation chart) but also a record low subordinated financial weighting too, as shown in chart 2.
Rejecting the industry narrative
Since 2017 we have been actively de-allocating from riskier credit and preferred investment grade and government bonds. This has clearly been counter to the industry narrative of a ‘government bond bubble’ and, we argued, illusory ‘value’ in illiquid and risk areas of the credit market.
Chart 2: strategy asset allocation through time
Source: Janus Henderson Investors, desk classifications, as at 31 January 2020
Note: Quarterly data points up to September 2009, monthly data points thereafter. Based on a representative account, which is believed to most closely reflect the current portfolio management style.
Must not overlook the opportunities
Our general view is that the coronavirus incident provides us an opportunity to add back suitable credits (which fit our style) at an attractive yield for the first time in a number of years. Though this would be selectively adding risk, given our relatively defensive strategic asset allocation.
We have been using the sell-off in credit as an opportunity to begin adding back credit risk, albeit being fully aware that the next few weeks will be a challenging time from a news flow perspective and markets are quite likely to roll down to even lower levels. This is the beginning of an averaging in process and we need to get going.
When we do come out of the coronavirus ‘recession’ we will be in a world of ‘zero interest’ rates across the entire developed world; central banks buying even more investment grade corporate bonds via quantitative easing, a stumble towards fiscal stimulus and a cleansing of the ‘value’ areas of the credit markets that have been zombies for years (high yield energy being the most obvious example). As a result, I would not be surprised to see even lower yields on quality corporate bonds by the end of the year than where we started.
This is not 2008
It is important to state that there is a not an endogenous sickness in economies or markets, which will leave scar tissues and take years to fix as was seen with the banks or the telecoms, media and technology (TMT) debt issues in previous cycles. There is also not a moral hazard issue as a result. Central bankers will, in my view, ensure that a global health crisis does not become a global liquidity crisis for on-the-run corporate investment grade credit. Private debt and collateralised loan obligations (CLOs) however, are a different matter.
I view the recent market moves triggered by the coronavirus as the culmination of a decade‑long regime in which quality outperforms value driven by a lack of structural growth, environmental, social and governance (ESG) and now compounded by a cyclical global collapse. It may well be the end of the government bond bull market with the final developed economies of the US, Canada and Australia falling back into the world of zero interest rates. From where we stand, I believe that there is little value or opportunity in government bonds other than as a short‑term hedge to risk assets.
What we can say is that the future need for sensible income will be more severe than ever.
We believe our portfolios are in good relative shape after several years of solid performance. Credit markets are suffering a severe sell-off in the short term for justified and obvious reasons. We expect significant outflows from funds which have been too highly exposed to riskier areas of the credit markets and view this as a potential opportunity to invest in corporate bonds that fit our style filter and a sensible yield.
Please read the following important information regarding funds related to this article.
- 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.
- 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.
- The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
- Callable debt securities, such as some asset-backed or mortgage-backed securities (ABS/MBS), give issuers the right to repay capital before the maturity date or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the fund may be impacted.
- If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
- 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.
- When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
- 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.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
- In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.