investment viewpoints
CIO views: identifying genuine relative value opportunities
As markets appear to stabilise, indiscriminate selling has created attractive relative value opportunities, in our view. But, this is not the time for indiscriminate buying.
We believe the current context requires an active, fundamental approach focused on quality and risk management to provide upside potential and downside protection across asset classes. The COVID-19 crisis has also highlighted that forward-looking analysis of sustainability dynamics is more important than it has ever been, and will be an essential factor in understanding genuine relative value.
Please click on the individual buttons below to read our CIO views by asset class.
Fixed income: credit spreads present opportunities.
Markets have experienced two distinct phases in COVID-19 crisis: an initial flight to quality as investors exited weaker credits, followed by a flight to liquidity as severe outflows and a collapse in market liquidity led to an indiscriminate selling of assets regardless of credit quality in order to raise cash. This indiscriminate sell-off presents, in our view, an opportunity as credit spreads widened significantly with little differentiation across issuers. We continue to actively monitor risks in our portfolios and acknowledge rating downgrades are inevitable, particularly in high and moderate impact sectors. Our credit analysts also aim to identify credit opportunities within the crossover segment.
We believe there is value in (i) high quality companies with the financial strength to withstand the crisis who are trading at incredibly attractive levels and offering an interesting new issuance premium (ii) fallen angels who are likely to recover as selling pressure subsides and companies focus on the improvement of their credit metrics. Although markets are likely to remain volatile, the current yield of 3.7% and 5.2% for Euro and Global crossover portfolios respectively offers a potentially attractive entry point to long-term investors as we aim to mitigate credit risk and provide diversified portfolios.
Click here to hear Yannik Zufferey, CIO Fixed Income, explain the current market situation and the implications for corporate credit strategies.
Asia fixed income: valuations are pricing in extremes.
The global liquidity shock in fixed income markets has been addressed by central banks, and further smoothened out with promises of significant fiscal stimulus. Going forward, we believe global debt markets will move through similar phases compared to the period after 2008/2009. This means broad-based ratings downgrades and a default cycle globally. However, this should result in a creditor-friendly environment at the same time. We expect companies will engage in asset sales, dividend cuts, cost cutting, reductions in capex and capital raising, which are supportive factors from a bondholder perspective. Liability management exercises will also be positive for high yield and emerging market credit.
In this environment, valuations are pricing in extremes. While investment grade (IG) markets are slowly opening again, IG spreads are still trading at 30-year records. Meanwhile, Asia and emerging market (EM) high yield (HY) is trading at steep discounts relative to US HY (ex energy). We believe credit could outperform in the coming years, especially in a prolonged U- or even L-shaped recovery, as the bulk of the increase in risk and liquidity premia is behind us. We expect large domestically funded markets like China to remain a bastion of stability within broader EM. India and Indonesia are well poised to retain their Investment Grade sovereign ratings through this crisis, which will help boost recovery sentiment going forward for Asia.
Click here for a comprehensive breakdown of key issues from Dhiraj Bajaj, Head of Asian Credit and Lead Portfolio Manager.
Equities: scrutinising the market for opportunities.
The first quarter of 2020 was the fifth worst on record, in terms of performance since WWII, down 22%. It is worth noting that similar drops in 1974, 1990, 2002 and 2008 were followed by some of the strongest rebounds two quarters later, usually followed by several years of market growth. With that in mind, we believe now is an opportune moment to scrutinise the market for buying opportunities in addition to monitoring liquidity risks of companies we are investing in.
While remaining focused on our key investment principles – sustainability of financial models, business practices and business models – our equity research capabilities are also focusing on identifying market anomalies. We are screening for companies that are not impaired, that should rebound and emerge stronger from the current turbulence. We are looking to identify companies that have been unduly disregarded by the equity market amongst the industries worst hit by COVID-19, as well as in traditional statistically rebounding industries.
We are preparing ourselves to build a defensive offensive across our strategies.
Convertibles: de-risking and re-risking naturally.
It is always worth reminding ourselves that convertible bonds naturally de-risk during market corrections and re-risk in up-markets.
Indeed, the market correction we have experienced since late February has allowed convertible bonds with good credit quality to prove their worth as a cushion during a historical drop in global equity markets. This largely indiscriminate correction has also brought to the fore single-name opportunities, as pockets of the investment grade universe of convertible bonds are now trading with wider spreads (and thus higher yields) than their straight bond equivalents. In addition, the equity option of these “yield plays” is an attractive “bonus” for investors despite their often medium-term maturity of 2-4 years.
We are also seeing potentially attractive opportunities to re-risk: we are currently witnessing the re-emergence among balanced profiles (high bond floors combined with meaningful equity optionality) of numerous convertible bonds from growth companies exposed to strong secular trends. These had previously been too equity-sensitive (and thus too far away from their bond floor) for our balanced strategies.
Click here to hear Maxime Perrin, Client Portfolio Manager and Senior Analyst Convertible Bonds, explain how convertibles could take advantage of dislocations.
Alternatives: a time of differentiation.
The investment landscape has been profoundly transformed by the COVID-19 crisis. Post panic and a relief rally, it is clear to us that it will be a time of differentiation. Differentiation within industries, between sectors, between countries, and we suspect, between active and passive strategies.
Companies that are strategically important, because of the number of people they employ or because of the importance of what they produce are likely to be more protected. Companies that are asset rich, have high revenue inelasticity and can continue to pay a dividend should fare better than those facing liquidity pressures and are asset light. Companies that seek government support may be prevented from cutting costs, putting pressure on equity valuations. Credit will be largely supported by central bank activities, creating opportunities for credit and equity differentiation. Countries that are more self-sustainable and do not have to import critical items are likely to do better. Some emerging markets might find themselves under particular pressure.
It is too early to tell the extent of these differentiations, but having more flexible investment vehicles could be a key advantage in the coming months. Relative value hedge strategies, for example, could benefit from relative value situations.
Sustainability dynamics: critical to identify genuine relative value.
The COVID-19 crisis has highlighted the importance of integrating sustainability for portfolio resilience. In developed economies, we have seen that companies with better ESG and sustainability characteristics have outperformed during the recent crisis. We believe this reflects their greater adaptability and risk management in the face of systemic disruption (including supply chain risk).
Green bonds are also proving their value as defensive and resilient investments. Nearly a dozen public sector issuers have issued social bonds to fund crisis responses.
The pandemic has also thrown a light onto the hidden economic and health costs of air pollution which is known to exacerbate the spread and mortality of infectious diseases. Harvard researchers have recently linked this to COVID-19 directly. This will continue to focus attention on the urgent need to transition to cleaner forms of energy and mobility, which we expect to see reflected in fiscal stimulus measures. This will further support long-term growth opportunities and competitive advantages for some companies over others across many different sectors.
As investors look to rebalance portfolios in light of the recent indiscriminate sell-off across asset classes, we believe forward-looking analysis of sustainability dynamics will be even more critical. Understanding how companies are positioned to seize the opportunities and mitigate the risks presented by sustainability dynamics will be essential to inform our understanding of genuine relative value opportunities.
Click here for more information on investing in the Climate Transition.
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