The coronavirus outbreak continues to broaden, and has killed more than 8,650 people thus far. Government efforts to contain it have led to the partial shutdown of entire economies – decimating company revenues, disrupting intricately connected supply chains, and severely jolting investors’ confidence.
The resulting volatility across major bond markets has been almost unprecedented. And it's led to a set of major interest rate cuts. The US Federal Reserve slashed rates by 100 basis points (bp) to near zero last week, followed by the Bank of Korea, which cut its rate by 50bp to 0.75% on March 16. The Reserve Bank of Australia then lowered interest rates by 25bp to 0.25% yesterday (March 19), and today Bank Indonesia trimmed its policy rate by 25bp to 4.5%.
Bond trading has proven to be challenging as liquidity has started to dry up. The spreads between bids and offers of US 10-year Treasury, for example, widened drastically in March, according to Refinitiv Eikon data. The outbreak has also caused corporate bond spreads to widen as companies scramble to raise debt to plug revenue holes.
In response to the outbreak, central banks next step is to expand quantitative easing stimulus packages to contain worsening economic conditions – the European Central Bank announced on Wednesday (March 18) its plans to buy €750 billion ($814.2 billion) worth of eurozone sovereign and corporate bonds.
These are unprecedented times for fixed income. Institutional investors and fund managers need to navigate this chaotic fixed income landscape, weighing which fixed income assets are likely to be most affected or most at risk of defaults, and considering how best to minimise liquidity problems too. It will be no easy task.
AsianInvestor asked nine experts to give their advice.
The followings extracts have been edited for brevity and clarity.
AK Sridhar, chief investment officer
IndiaFirst Life Insurance
Bond yields have come down over the last six months and more steeply in the last one month. There is surplus liquidity in the short end. We expect [India’s] interest rates to go down a little further and rates in general to remain subdued in this region for three to four quarters.
Considering the fiscal deficit situation of the Indian macroeconomy and very little manoeuvrability, this low interest rate regime will have to change – but it’s difficult to gauge as to when and how soon.
We have been long on our debt exposure all along, but will cut short the [bond portfolio’s] duration within the next quarter or so. Going back to long is not envisaged now. That's going to give us a fair amount of challenges in terms of what the bond portfolio will earn in the near term. We will also actively increase our allocation to alternative investment funds and to other asset managers seeking for higher returns, although this might happen only after one or two quarters from now.
We will primarily focus on duration management than on different types of bonds, keeping around 55% in long government bonds and high rated corporate bonds of relatively shorter duration. As a regulated entity, we can only have exposure to rupee-denominated debt. However, my recommendation would be to select Southeast Asia emerging markets and the US, and less of Europe and other developing economies.
Jim Veneau, head of Asia fixed income
Axa Investment Managers
Emerging markets and high yield have been the most impacted, so far. However, the worsening liquidity makes ordinary portfolio management challenging and extraordinary portfolio management (like raising cash for redemptions) almost impossible. This isn’t limited to credit – we have seen a fairly significant rise in US Treasury yields despite rate cuts and Fed commitments to buy longer dated bonds. These are not normal times, to say the least.
In this period, we have reconciled that the market will reprice to severe levels but a bottom will emerge in cash credit before any other asset class. Companies that don’t default will, by definition, repay at par. This gives credit bond investors increasingly high conviction that bond prices will ultimately rebound so long as there is no default.
That is the one big caution. This historically unprecedented halt in global economic activity will almost certainly increase global default rates. The bond prices of issuers that default will be at extremely low levels, and even then ultimate returns are uncertain – making defaulted bonds tantamount to an equity investment.
The best strategy in this environment is to monitor bond prices (not necessarily yields) of higher quality BB and even BBB bonds, and bonds from issuers that may have reduced earnings and cash flow but sufficient flexibility to avoid defaulting. Investors can then lock in an essentially guaranteed return for the cost of some volatility.
Adrian Hull, head of UK fixed income
Aegon Asset Management
Markets are in panic mode and liquidity is the only driver of fixed income assets. This has seen the US dollar rise sharply but has also led to the liquidation of US Treasuries as sovereigns, corporates and wealth managers seek to deploy cash to real economies.
Fixed income markets across the globe are seeking to respond to new policies from governments and central banks as they meet the challenge of coronavirus. Meanwhile, traders are comparing severity of markets moves to 2008, 1998 or 1987.
Credit markets have sunk in value with subordinated bank paper and high yield bonds being hit hard. US inflation markets are pricing virtually no inflation as markets see no end in sight for the virus or its decimating economic impact.
There will be a time when we will see some of today’s credit valuations as appealing. However, issuers with weaker balance sheets will weigh heavily and on many banks along with fears of contagion and liquidity risk. Valuations are likely to be more stressed before there is a finite outcome to Covid-19’s economic impact which provides greater certainty to valuations.
It’s all about liquidity. Current trading conditions are tough, government markets uncertain. Credit purchases could prove attractive but need to be well researched and will be subject to ongoing price volatility.
Sriram Reddy, investment director for European and global credit
In credit markets, the unwind in the corporate credit spreads has been severe, with spreads widening across all sectors. It’s been particularly pronounced among sectors with a higher sensitivity to the economic cycle, those perceived to have the greatest direct risk from the Covid-19, and lower rated credits.
While we saw an improvement in economic activity early in the year, we felt then that the potential for positive macro news was fully reflected in credit spreads, particularly in the high yield market. At the same time, there was very little room for yet unknown bad news to be priced in, particularly amongst the more cyclically-sensitive (higher beta) investment grade credits.
This view has been reflected in the relatively defensive positioning in our global credit income strategy, with a preference for investment grade over high yield and a quality bias with regards to the capital structure with a preference for senior unsecured debt rather than subordinated financials.
From a sector perspective, we have felt that cyclicals were not pricing in much of an additional premium and avoided many of the hardest hit sectors with a relatively modest exposure to energy focused on pipelines and integrated energy. We’ve maintained exposure in areas where we see the cashflows to be potentially more resilient, such as in real estate (i.e. residential accommodation), selected telecoms issuers, and healthcare.
Joubeen Hurren, senior portfolio manager, multi-strategy fixed income
Credit markets in particular have seen a severe reduction in liquidity following the realisation the coronavirus will damage the global economy, and the subsequent monetary and fiscal policy announcements.
Announcements indicating massive debt issuance by governments around the world have resulted in sharp upward moves in sovereign yields, most recently exemplified by US Treasuries. Changing market structure dynamics such as the rise of risk-parity portfolios, which have been forced to cut leverage, have exacerbated the sharp moves.
We believe traditional fixed income exposures continue to present opportunities. While rates are already very low, Treasury yields can move lower in a world where the Fed acts decisively, as it recently did with a 100 basis point rate cut and additional measures to support liquidity. However, flexibility is what is really required if investors are to navigate the current chaos and position themselves for what could be extraordinary investment opportunities.
Taking synthetic exposures can be highly advantageous in periods of market dislocation, for example neutralising illiquid credit holdings through the use of credit default swaps. Short positions also widen the range of opportunities, while fiscal policy interventions could also provide investors with interesting opportunities to benefit from changes in the shape of yield curves.
Khiem Do, head of Greater China investments
At present, uncertainty reigned supreme.
While the Covid-19 situation in China and other North Asia countries has stabilised, the rapid acceleration of the contagion effect in Europe and the US forced them to impose strict measures to isolate themselves. This caused many economists to forecast a global recession in 2020, which, some expect, could be deep and long.
This had a significant impact on how investors assess the relative attractiveness of economic-sensitive assets (equities, high ield bonds, emerging assets in USD and local currency, commodities) versus more defensive ones (OECD government bonds, OECD investment grade bonds and precious metals).
While it is tempting for conservative investors to stay invested in low-yielding OECD government bonds, as the credit spreads of OECD Investment and high yield bonds blew out significantly, the latter have started to reflect the low oil price and rising corporate default rates, symptomatic of a global recession scenario.
Thus, depending on the risk profile and investment horizon of the fixed income investor, it may pay for those who can assume some risk and a long term horizon, to think of gradually accumulating OECD investment grade bonds and emerging dollar debt, and consider an exposure to a diversified high yield bond fund with a small exposure to energy.
Rong-Ren Goh, portfolio manager
Before the spread of Covid-19, an unprecedented period of low volatility encouraged leverage and carry trades to prevail. The VaR shock which has ensued since has caused these positions to simultaneously unwind, creating market dislocation and liquidity vacuum in risk assets.
As investors scramble to raise cash no segment is being spared, including local currency risk-free government bonds. Bonds have sold off proportionally to their level of risk – thus high yield has unperformed investment grade bonds. High yielding local currency govvies – from the likes of Indonesia – have also sold off considerably.
In the larger scheme of things, this has recreated value across fixed income markets. Credit spreads and FX levels have corrected considerably to provide very attractive entry points for long-term investors.
If effective containment measures are put in place globally, the virus spread in US and Europe can be seen as a one-off economic drag, which would help conditions start to normalize by the second half of the year.
Policymakers have been willing to take pro-active steps to front load easing measures to support the economy, both on the monetary and fiscal fronts. These measures will remain in place for a considerable period of time to provide further support to asset markets.
Investors should therefore position their fixed income exposures for improved economic conditions post the transitory shock from Covid-19, and persistently lower rates, which advocates accumulating risk on their fixed income portfolios.
Paul Sandhu, Asia-Pacific head of multi-asset quant solutions and client advisory
BNP Paribas Asset Management
Clearly the asset class most affected by markets is equity, but correlated with equity is high yield bonds where the spread has widened substantially and liquidity has dried up. However, as was with the global financial crisis, opportunistic buys of investment grade bonds, mostly A-rated at attractive yields, are starting to show themselves and investors able to conduct good credit analysis and pick up these bonds will have a leg up.
Jason Brady, president and chief executive
Thornburg Investment Management
The role of fixed income has changed over the past 10 years, and dramatically over the past two decades. Relying on high quality fixed income as a source of income is no longer practical, now that it has been weaponised very explicitly as a policy objective by several global central banks, particularly through the use of negative yields. Using it as a portfolio ballast with low or negative correlation to equities or other risk assets is also fast disappearing.
On the plus side, the diversity of risks and opportunities in fixed income is exploding. Most recently, the market downturn has presented big total return opportunities that investors can and should take advantage of. While it is impossible to buy the bottom, the risk/reward calculus is changing dramatically.
By transferring lending to the marketplace from the banking system, regulators have created a flexible but occasionally brittle system. Investors should be wary in most instances, but recently, the opportunities in fixed income are bountiful.