Fixed Income: “We all need to re-evaluate our concepts of fair value”


The current bond market characterized by low yields, low yields, and speculation on stagflation has left fixed income investors divided on the best approach. Some dive into riskier assets while others reduce their exposure.

Nick Hayes, who heads the AXAWF Global Strategic Bonds, thinks it comes down to post-Covid reassessments.

“We’ve been through something that neither of us have experienced before. And so, we all need to re-evaluate our concepts of fair value, ”said Hayes.

Citywire selector asked five bond investors how they handle the low-yield environment.

High yield hunting

“In an era of weak growth, financial repression and low returns, generating income for investors means there is no free lunch,” said Peter Khan, who co-manages the Fidelity Global Income fund.

Khan has increased his high yield exposure to developed markets by 7% since the end of October last year. It now represents 29% of the portfolio while investment grade exposure stands at 41%. The high yield has been allocated to cyclical zones in sectors such as basic industries, capital goods, energy and transport.

In recent quarters, the fund has also reallocated some of its exposure from convertibles to leveraged loans via total return swaps and other floating rate instruments, due to the strong performance of the equity market. Khan is also considering asset-backed securities, which make up about 2% of the fund, and local currency debt securities from emerging markets.

Khan and his team believe high yield is well placed in an environment of rising rates and inflation expectations and noted that the carry component of expected returns also became more attractive in the middle of the year.

Likewise, the higher-rated Hayes (pictured above) has increased the high-yield developed market exposure in his portfolio to around 40% over the past three months.

“People are wary of fixed income securities because the yields are too low, but the yields are low because the extremely positive techniques are driven by central banks but also by regulators, entities, pension funds. So I think you can make more money than people think, ”Hayes said.

When valuations are negative and spreads tight, the rationale for adding high yield, Hayes said, can be found in the technical data.

“You can’t add high return just on a fundamental basis. A combination of fundamentals and decent valuations is not the reason to be bullish, but you can find valuations with a positive technical background. ‘

Hayes’ high yield allocation consists of approximately 8% CCC-rated short-term bonds in US healthcare and financial services companies.

In Europe, he added exposure to subordinated debt of high-quality utilities and telecommunications companies, as well as BB and B-rated opportunities in financial services and insurance.

“I think there is still a bit of a ‘beta premium’, as people worry that financials are super volatile or may suffer from an economic downturn – which is true they will, but we think they’re better positioned than the market expects, ”said Hayes.

“Banks and insurance companies are pretty well capitalized animals and much more conservative than they were before the global financial crisis, and from that perspective the fundamentals are pretty strong.”

Risk-free returns

Federated Hermes head of fixed income Andrew Jackson (pictured above) offered a mixed perspective. His bond team is running roughly the same level of risk as at the start of the year, slightly lower than the indices.

The Federated Hermes Unconstrained Credit fund, which offers the highest risk exposure, allocated only 50% to high yield with limited exposure to single Bs and no exposure to triple Cs, making the risk level of Jackson weak compared to his peer group.

“We’re basically telling investors that there are still things in fixed income securities that you can invest in, which doesn’t necessarily mean you’re betting on low leverage or a load of risk,” Jackson said. .

The current threat to bond investors, he says, comes from two directions: increases in underlying interest rates coupled with a high level of duration, and a simultaneous widening of credit spreads. That, Jackson said, hasn’t happened for at least a decade.

“There is a real possibility that, for the first time in a decade, interest rates and credit spreads are correlated in parts of the fixed income markets,” Jackson said, citing the enlargement as an example. credit spreads and tightening interest rates last year. .

Rather than taking more risk, Jackson’s team focuses on identifying poorly priced markets, where there are returns without the corresponding level of risk.

He cited structured credit as a prime example, which trades at a credit spread that does not reflect the amount of risk involved. Subordinated instruments issued by “clean enough” borrowers, ranging from subordinated financial debt to hybrid capital instruments issued by utilities or energy companies, can also offer promising returns.

Investors should also seek arbitrage in currency and technical aspects of the market, Jackson said. For example, buying a euro-denominated bond from a dollar issuer, which is currently paying a few basis points above dollar-denominated bonds.

“Doing this stuff, as boring and boring as it is, is where we want to focus our time,” Jackson said.

Reduced exposure

Jackson believes the recent price revision has pushed the high yield relative to the investment grade to “decent relative value,” but AAA-rated Alex Pelteshki of the Aegon Strategic Global Bond fund – the second best performing fund in its class Citywire over the past three years – think differently.

“I reduced my exposure to the high yield market because I don’t think the prices fundamentally reflect reality.

“Fixed income investors have been pushed into higher yielding assets or more artificial assets relative to their own investment mandates, and prices have been pushed very high across the board,” he said. declared.

Pelteshki reduced its high yield exposure to almost zero in the middle of this year, but increased it to 5% in the past three months as prices became slightly more attractive.

Jon Jonsson, co-manager of the Neuberger Berman Global Opp Bond fund, is another fund manager who has reduced his exposure.

Jonsson’s team have reduced their exposure to high yield “significantly” over the past three months, but remain overweight. Their current EU high yield allocation is geared towards B and BB rated telecommunications and cable.

However, after 18 months of unprecedented fiscal and monetary stimulus and rapid asset price appreciation, Jonsson sees the fourth quarter as a potential inflection point for bond investors as the market passes peak growth. and that central banks begin to slow monetary easing.

“We believe investors should reorient portfolios for increased volatility and a more two-way investment environment that will likely emerge in 2022.

“While we continue to focus on seeking yield with limited duration risk, this may mean taking profits, leaning towards higher quality credit exposures and maintaining liquidity to deploy when volatility opportunities arise. present, “Jonsson said.

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