15 Sep 2021
Portfolio managers Sajiv Vaid and Kris Atkinson discuss why fixed income investors should be cautious of underweighting duration and reaching for yield in the current environment. They review the opportunity set in high quality investment grade credit and reveal how the Fidelity MoneyBuilder Income Fund is positioned to deliver a balance of income, downside protection and diversification away from equities.
Key points
Valuations in credit markets look rich with credit spreads (the additional compensation investors receive for lending to corporate issuers over government bonds) across many markets close to 10-year tights. As such, many investors are accepting current low volatility levels as the ‘new normal’ and appear more willing to compromise liquidity by reaching for yield and adding to high yield credit and unrated bonds to lift income. On top of this, low core government bond yields and concerns around tapering and inflation are leading many investors to underweight duration.
It is quite ironic that at the point when valuations look expensive, investors start adding riskier assets. We would caution against this approach, particularly for those investors looking to preserve the core attributes of bond investing.
We aim to offer what we term the three-pillars of bond investing - a balance of income, downside protection and diversification away from equities. Accordingly, we prefer to have a good balance of high-quality investment grade credit and interest rate risk in our portfolios. Ultimately, it is duration that helps to preserve a low correlation to equities and high-quality credit offers an income pick-up over government bonds, while exhibiting less risk than high yield credit.
While credit valuations look rich at the aggregate level, we are finding selective value under the surface, largely in the asset-backed market and certain Covid-19 sensitive areas. The asset-backed sector (ABS) continues to offer a higher level of income than regular corporate bonds. These bonds benefit from being secured on assets or income streams and we believe this is the best way to navigate the uncertain economic backdrop that lies ahead in the post-Covid era.
Within the Fidelity MoneyBuilder Income Fund, we are overweight ABS versus the index. This includes a diverse range of underlying economic exposures across the auto-recovery sector (with names including AA and RAC); key infrastructure assets (such as Channel Link, which is secured on the Channel Tunnel); and property (like bonds secured on the Westfield shopping centre), among others.
On top of this, areas most sensitive to the fall-out of the Covid-19 impact are leisure, travel and infrastructure assets, and we continue to see value on a single-name basis in these areas. We have taken a very selective approach, however, and framing our appetite is looking at how companies have adopted self-help measures such as raising liquidity (via equity, debt or both). We have also skewed our preference towards domestic rather than international re-opening trades.
For example, we own Heathrow bonds in secured format which offer a credit spread ranging from 152 basis points (bps) to 168bps versus the index at 88bps. While some of these areas have done well so far in 2021 - and we have been taking some profits - we still see opportunities.
Outside of credit, the clear concerns remain the outlook for inflation and the overall direction for yields and these questions are unlikely to be resolved in the short-term. We remain firmly in the lower for longer camp and, while acknowledging current concerns, we lean on the side that much of the inflationary pressure is transitory. We therefore believe that duration should be kept closer to neutral (rather than being materially underweight or outright short) as we have likely seen the peak in yields for 2021. It is important to bear in mind that duration supports income generation and reduces equity correlations, which we see as attractive benefits for a well-diversified portfolio at this point of the cycle.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the Fund investing in them. Fidelity’s fixed income range of funds can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.