13 Nov 2020
5 November 2020 | Ariel Bezalel, Head of Strategy, Fixed Income
Ariel Bezalel, Head of Strategy, Fixed Income, explains the appeal of a global flexible bond strategy, sharing his views on the macro environment and the corporate credit and government bond markets.
The beautiful thing about a global flexible bond strategy is that it is not constrained by an index or geography or a type of credit. High yield, investment grade, developed markets government bonds or emerging markets: you can move wherever you see the best opportunities.
We continue to be constructive on government bonds despite the very low level of yields. The Federal Reserve’s stated policy of allowing higher inflation and periods of overshooting the inflation target cannot be met if real yields are allowed to rise. Yields can only go up so much in such a highly indebted world.
We remain firmly of the view that we are in a deflationary environment rather than an inflationary one. The outlook for the economic recovery seems to have deteriorated, and for inflation to increase, economic activity will have to recover sharply. Demographics and technological disruption are powerful long-term suppressants of government bond yields, and the huge rise in debt levels over the crisis is likely to remain a drag on economies for some time.
Coming into the year we had a fairly cautious stance on credit, and from March onward we became much more constructive across both high yield and investment grade. As we said, we do not see interest rates going up anytime soon, and central banks really showed their hand in March and April with moves to backstop the credit market.
Investment grade and high yield bonds are a good place to be because of central bank support, but you must get your credit analysis right. The economic growth outlook continues to be challenged, and that leaves a lot of business models looking highly questionable, in particular, companies that are heavily exposed to the economic cycle and those that are highly leveraged. Default rates have climbed in the US and will continue to do so, and some well-known companies have filed for bankruptcy this year.
Debt (% of GDP) vs. 30 year government bond yields
Rising debt levels leads to falling yields
Source United States: Federal Reserve, O.E.C.D, Haver Analytics. Through 2019. Japan: Ministry of Finance Japan, O.E.C.D, Haver Analytics. Through 2019. Euro Area: European Central Bank, O.E.C.D, Haver Analytics. Through 2019. United Kingdom: Bank of England, O.E.C.D, Haver Analytics. Through 2019.
It is important to choose companies with the right business model and level of leverage to ride through an extended period of economic volatility. For example, some fast-food and food delivery companies, supermarkets, pharma and television streaming services have been booming during the Covid-19 period.
In high yield, we see opportunities in BB rated companies and in more defensive sectors. With the right credit selection, investors can pick up yields in a range from 3% to double digits in names that will provide the opportunity to get the coupon plus the return of principle.
In investment grade in March, spreads implied significant default rates. There were compelling opportunities in BBB and single A, and while much of that has played out, you are still able to get in these select names over and above what you can get in government bonds.
Global flexible bond investors also have a range of tools available to look to preserve capital. That includes credit default swaps to mitigate risk, AAA rated sovereigns, and the use of currency as a hedge. We continue to favour AAA sovereigns because, as we said, we believe the world is more susceptible to a deflationary shock than an inflationary one. Covid-19 seems like it is going to be with us for some time, and it has created a lot of scarring for the global economy.
In government bonds, moving further out on the yield curve, there are places where you can find positive yields, including America and Australia. Longer-dated Australian government bonds are interesting because of the potential for further easing measures by the country’s central bank.
Ten-year Chinese government bonds are one of the few sovereigns offering a positive real yield today at around 3%. Meanwhile, five-year Russian government bonds in local currency offer yields in excess of 5%. Russia has some big problems, including demographics, and we think rates there will move lower over time so there could be potential for capital appreciation.
Our view is that within the current monetary framework it is going to be difficult to generate inflation, and therefore the benign outlook for government bonds and corporate debt is very much intact. Flexibility is going to be crucial in what will undoubtedly be a challenging macro environment over the next 3 to 5 years, and global flexible bond strategies offer the tools to manoeuvre through that world.
Please note: Market and exchange rate movements can fall as well as rise, and you may get back less than invested.
Important Information: This document is intended for investment professionals and is not for the use or benefit of other persons, including retail investors, except in Hong Kong. This document is for informational purposes only and is not investment advice. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. The views expressed are those of the author at the time of preparation and may change in the future. Issued by Jupiter Asset Management Limited which is authorised and regulated by the Financial Conduct Authority, registered address is The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ, United Kingdom. For investors in Hong Kong: Issued by Jupiter Asset Management (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission. No part of this content may be reproduced in any manner without the prior permission of Jupiter Asset Management Limited or Jupiter Asset Management (Hong Kong) Limited. 26530/20303