investment viewpoints
Outlook 2021 – fixed income
The sustainability transition to a Circular, Lean, Inclusive and Clean (CLIC™) economy
Sustainability is at the forefront of our investment decisions whether we look at a company or a country. Early in this journey, we recognised the importance of integrating sustainability into our corporate bond portfolios and more recently in sovereign and money market strategies. At the core of our strategies sits the belief that risk mitigation and, therefore, capital preservation1 are crucial to adding value. Sustainability supports this belief by identifying the companies and countries best suited to the demands of a low carbon, low temperature, resource-scarce global economy and, therefore, adds resilience to our portfolios, which we believe is key particularly in these volatile markets.
The supply of green bonds has increased significantly this year with many new issuers and new instruments, including green subordinated debt from financials, green hybrid bonds and even green high yield bonds. This is a significant improvement as the supply of green assets is becoming available across all different types of debt securities and across the rating spectrum. We have also seen more sustainability-linked bonds where the coupon steps up if a specific sustainability target is not met. We believe this area will grow significantly over the next few years as it allows less capital-intensive companies to issue “green” bonds where investors are supportive of the company’s strategy rather than a specific project.
In our view, the COVID-19 crisis has strengthened the case for an active and sustainable management of portfolios in a world where uncertainties remain. Therefore, our aim is to mitigate risks by identifying high quality companies (i) with a sustainable business profile and (ii) that are transitioning towards a better-aligned business model. In addition, we focus on finding innovative alpha sources by selecting issuers that benefit from the transition towards a CLIC™ economy.
When it comes to sovereigns, our investment philosophy is grounded on the same principle: a focus on countries’ sustainability. With a growing issuance of green bonds from governments, we expect similar developments to those for companies. Moving forward, we expect sustainability to be a driving force for investments, as we see an intensification of the shift in the economy to cope with this new reality.
The Covid-19 crisis has strengthened the case for an active and sustainable management of portfolios in a world where uncertainties remain.
What will a post-coronavirus world look like?
The unprecedented COVID-19 shock is a turning point for the global economy. The post-COVID era could mark the beginning of a brave new world where the entire value chain needs to be reassessed, as things will never be the same. The recent positive news on the vaccine front has brought hope and triggered a broad-based rally in risk assets including fixed income. In addition, we expect the easing of global central bank policy to persist through a combination of sovereign and corporate asset purchases.
The “search for yield” environment has been reinvigorated by the extraordinary monetary policy stimulus that was delivered across markets in the wake of the COVID-19 shock. In this context, credit markets and especially the Crossover and HY segments look attractive. The recent rally has lowered the overall spread level, but spreads have not reached pre-COVID levels yet, especially in the high-beta segment. We expect more compression trades and sector rotation should offer value and further spread tightening potential. COVID-sensitive sectors still have room to catch up amid high spread dispersion. While we continue to closely monitor risks, we see value (i) in COVID-sensitive sectors, such as autos, with a focus on strong and sustainable issuers as long-term risks remain, and (ii) in going down the capital structure to invest in fundamentally solid companies.
On the sovereign side, we think that emerging markets (EM) have a role to play as we enter into 2021. Despite a challenging year where yields have reached historical lows, EMs continue to provide an attractive yield compared to advanced economies. Within EM local currency, we favour sound economies and have reduced the exposure to fundamentally “vulnerable” countries such as Brazil or South Africa. We like Asian markets, where the growth pathway looks favourable amid the Covid-19 shock. ESG integration is also key in our country assessment which has proven to be effective in mitigating risks.
In terms of money markets, aggressive central bank accommodation is making life hard for cash investors who face zero or negative returns in nearly all developed markets. In addition, central bank lending facilities are providing attractive funding to the banking sector, which is now bypassing the money markets to obtain lower cost funding directly from these programmes. This also creates tight supply conditions in a money market flooded with liquidity. Therefore, we believe that enhanced cash strategies, like ultra-low duration bonds, are a good solution for investors with slightly longer horizons for their cash investments.
Overall, the prospect of the roll-out of effective vaccines provides a powerful tailwind for economic activity going into 2021. However, the road ahead is set to remain bumpy as the pandemic is leaving lasting scars for corporates, households and governments in particular. In this environment, we believe that active management and rigorous bottom-up analysis are crucial across fixed income portfolios in pursuit of opportunities.
What are the likely consequences of a Biden Presidency?
Market participants and the public at large have keenly awaited the outcome of the US presidential elections. In line with the polls, the Democratic nominee Joe Biden did win the elections by a comfortable margin. However, the Democratic party failed to gain control over both Houses of Congress, with the Republicans set to retain control of the Senate. Some uncertainty remains as this outcome is conditional on the re-election of the two Republican senators in the Georgia runoffs to be held in January. With a divided government additional fiscal stimulus is likely to be relatively modest.
With respect to globalisation, a Biden presidency is set to deliver a return to multilateralism and a more cooperative US approach to global issues. However, trade tariffs and protectionism will remain part of the policy agenda. When it comes to sustainability, Joe Biden called for 100% renewable energy by 2050 and for the US to be carbon neutral by that date during his campaign. While Biden, with a divided Congress, will not be in a position to fully deliver on this plan, his ambitious carbon neutral goal stands in stark contrast with the withdrawal from the Paris Accord that was announced by President Trump in 2017.
Turning to the impact on markets, lower uncertainty has recently boosted investors’ sentiment with significant flows in risk assets since the US elections results. Biden’s election is a positive outcome for credit and particularly for emerging markets (EM) which benefited from this positive momentum. We have become more optimistic towards EMs over the medium term on the back of recent news, but remain extremely cautious, as idiosyncratic headwinds remain part of the EM landscape. With regards to corporate bonds, we structurally favour the Crossover segment – bonds rated BBB to BB – which should be well positioned over the medium to long term. However, active and rigorous security selection are key to avoid falling knifes.
Overall, the expectations of a less volatile international political landscape, with a Democratic-president elect and combined with progress on the vaccine front bode well for the 2021 outlook. However, caution remains key as the COVID-19 implications have not unfolded in full yet.
sources.
1 Capital preservation represents a portfolio construction goal and cannot be guaranteed.
important information.
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