Over the first half of 2020, the fixed income managers we have interviewed have gone through three distinct phases. Initially, during the market sell-off of late February and March, their focus was on trying to ensure they had sufficient liquidity within their portfolios. Then, from the end of March, throughout April and to a lesser extent in May, they began to reintroduce risk in response to the unprecedented stimulus from governments and central banks aimed at supporting economies worldwide. This re-risking was also due to the attractive valuations available, particularly for solid, investment grade companies with low default risk and in the new issuance market.
Most recently, however, managers have taken time to step back and take stock of markets. While governmental and central bank intervention which pumped significant levels of liquidity into the system heartened many managers, valuations are not as attractive as they were as spreads have tightened. They are also paying close attention to the emerging corporate results and macroeconomic data which are not altogether positive. There has been a considerable decrease in productivity, in growth and in profits globally which suggests a disconnect between markets and the real economy. This has led to some scepticism among fund managers over the sustainability of this market recovery. However, although their outlook is cautious, they continue to maintain elevated levels of risk within their portfolios, perhaps for fear of missing out on any further market rallies.
As a team, we have observed certain interesting emerging trends, in particular in relation to fund managers’ stance on duration and inflation. Before the Covid-19 crisis, managers were concerned with structural disinflationary factors such as ageing demographics, high levels of debt, disruptive technology and reduced levels of consumption. Some of these factors are expected to accelerate as a result of this crisis as consumers reduce their spend and businesses shut down. In contrast, the fiscal and monetary stimulus from governments and central banks could have an inflationary effect. Ultimately, however, central banks are likely to keep a cap on yields to maintain affordability in the face of higher levels of debt. Overall, there is a sense that inflation is not a cause for concern.
So, with this “lower for longer” outlook for interest rates, we have noted that managers are increasing duration in their portfolios. This is true even for those that were structurally underweight duration because they could not see any value in low interest rates. While this is still of concern for the most part, they see reflationary forces as more of a ‘next year problem’ or beyond, when economies start to emerge from lockdown. They also recognise the pressure that central banks are under to control yield curves and to keep interest rates at very low levels which justifies their willingness to take longer duration positions, at least for now.
Eduardo Sanchez, Senior Investment Research Analyst
Source: Square Mile Investment Consulting and Research Limited. Investment Partners to Ernest Grant.
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