While commentators have been shocked, disappointed or underwhelmed at the lack of seriousness with which many governments have approached the global Covid-19 pandemic, the response of central banks to the financial fallout has both surprised and impressed financial experts.
“Having the misfortune to have been in the markets through several crises, certainly the scale, the speed, the lack of delay before responding has been, some would say impressive, others would say, perhaps, a little bit quick off the mark,” said David Roberts, head of the fixed income team at Liontrust in a recent video interview with PWM.
There are three key reasons, he explains, for the unprecedented institutional response. The first was to maintain stability, the second to shift the debt burden from banks to retail investors and pension funds and the third to increase confidence through further bond-buying, carrying on a programme of “market manipulation” in the guise of quantitative easing.
Mr Roberts expressed some reservations about the consequences of dabbling in free markets, with their potential of further fuelling long-term inequality.
Hands tied
Yet the hands of these institutions, particularly the European Central Bank, have been tied to a great extent. “What we’ve really had is a decade where central bankers, across the globe, but especially in Europe, have set the price that we will pay for bonds and, by extension, many other assets.”
What is new, is that policymakers – especially ECB president Christine Lagarde – are beginning to put pressure on the European Union for more co-ordination in fiscal policy. This is something the “great European experiment” has been missing for nearly 50 years and could be about to change. “They say it’s an ill wind that blows no good and perhaps, if the Covid crisis leads to a stronger, more unified Europe, then that may be one of the few good things that comes out of it,” he said.
Many have claimed this unprecedented central back liquidity in response to the fastest fixed income sell-off in history, combined with the widest spreads since the 2008 crisis, left us with a unique window of opportunity to buy into investment grade bonds.
But Mr Roberts is not so quick to jump to conclusions of a bond-buyers’ nirvana. “Some people have described it as a ‘once-in-a-lifetime’ opportunity,” he said, smiling. “But, but I would say, in my career, there seemed to have been three of four of these once-in-a-lifetime opportunities.”
Nicely underweight
Liontrust entered the crisis with a 30 per cent “nicely underweight” allocation to investment grade in its fixed income portfolios, compared to a 50 per cent neutral position in the market, identifying a lack of value. But this afforded the boutique funds house the luxury of boosting the position up to 60 per cent during March, to take advantage of opportunities presenting themselves.
Sovereign yields are now expected to remain low “for years, with dividends being cut almost by the day”. For those seeking conservative and reasonably stable income, there is still a place for the investment grade asset class in investors’ portfolios, believes Mr Roberts.
Against this macro-economic background, most of the money made by bond investors has so far been outside Europe, in the US, Canada and Australia, which have outperformed the core European markets.
There is now room for gains in Europe, but the policy agenda would need to change, said Mr Roberts. “It is really difficult to justify interest rates at or below zero when we have positive economic growth, as we have had in Europe for nearly 10 years now,” he said. “I am very much a pro-European. I hope that this period inspires a greater degree of fiscal co-ordination, encourages some of the northern nations to loosen the purse strings slightly and to allow the ECB the flexibility to raise rates as and when the good times come back, to give themselves a degree of firepower to allow investors an opportunity to diversify and buy a risk free asset again, to protect against future periods of uncertainty.”
This notion of interest rates as a tool, part of an economic and management suite and not simply the “be all and end all of stimulus package” would key to this message. “We like the asset mix that the ECB and the Fed is buying and that’s really where we are concentrating,” ventured Mr Roberts. The value in investment grade and high yield, backed by support from the monetary authorities, gives Liontrust more confidence to invest in these markets than hard currency emerging markets, for instance.
“Strategically, we think high yield is a place for almost everyone in their portfolios,” he said. Whereas his weighting of more than 30 per cent during March is now down to 20 per cent, Mr Roberts still sees high yield as attractive on a long-term basis, with several caveats. Number one is quality, with the upper echelons of single and double B bonds preferred. Defaults of companies in the triple C range are likely to increase.
Secondly, sector is also important, with current underweights in travel, tourism, energy and high street retailers, but “carbon light” opportunities being brought to the fore. With the high yield market offering a yield of 4 per cent plus in euro terms, over a five year period, investors can gain 20 per cent from income alone.
“Now, there’s nothing to say that high yield can’t collapse again, but I would suggest if we saw a 20 per cent loss on high yield then we would probably see the DAX or the CAC down 30 per cent,” ventured Mr Roberts. High yield, he concluded, if compared to most alternatives, is a very attractive asset on a relative value basis.
US elections
Bond experts at Liontrust have been busy modelling political scenarios, especially the effect on markets of different results in November’s forthcoming US presidential election.
“Certainly, in my lifetime, it’s difficult to imagine a, a democratic candidate quite so near the centre, shall we say,” suggested Mr Roberts. “Trump and Biden are arguably two sides of the same coin.” There are also certain aspects of their approach, dictated by the legacy of Covid-19, that necessitate their crisis responses as being relatively similar, he added.
If Mr Biden achieves a better-than-expected majority in the poll, we could see “a small rise in corporate tax and, perhaps, a modest redistribution of income through the different strata of American society,” said Mr Roberts.
“That would be sufficient to start to reduce some of the inequalities and, potentially, boost consumption in the US and, hence, be good in the longer term,” he said. Arguably, this would be “little bit bond friendly” in the short term and more positive in the longer term, “unusually perhaps for a Democratic president”.
The prognosis for another Trump term would be more protectionism, a universal tax hike to finance the ever-expanding US deficit, essentially “a tax on everyone who is invested in markets” and continuation of the “America First” policy. A Trump victory, reckons Mr Roberts, could lead to further pressure on the Federal Reserve to maintain interest rates at currently level and potentially to lower them. This lays the way open for further presidential interference, reducing the Fed’s independence and leaving its boss, Jerome Powell, increasingly looking over his shoulder.
