Traditional fixed income sleeves will take an entirely different shape in the post-pandemic era, with the allocation of negative bond yields and cash investments hard to justify in portfolios according to Sunsuper head of asset allocation Andrew Fisher.

Speaking on a live panel at this morning’s Professional Planner Researcher Forum 2020, Fisher explained how the fund’s allocation to fixed income is set to change as the economy drags itself out of a recession and markets tilt themselves back to a more rational setting.

“Roughly speaking, aggregate investment today is 60 per cent sovereign and 40 per cent investment grade credit,” Fisher said. “That’s what fixed income looked like.”

That may not be the way it looks in 2021, however. The depressed state of sovereign bond returns, especially, is forcing institutional investors to reimagine their defensive strategy.

“Coming out of this crisis and where we find ourselves today, we don’t think that’s going to be a sufficient way of allocating to fixed income,” Fisher continued. “A large part of that is what’s happened with sovereign bond yields.”

European government bonds in particular offer little for portfolio managers, he believes. “Through 2020 European bonds have basically returned zero, give or take, because bond yields were so low at the start they really had nowhere to go,” he told the panel.

From that point on those investments have little benefit. “They’ve got no value above holding cash really and they do present a pretty meaningful risk because bond yields can definitely go the other way on those assets,” he warned.

“So, we’re thinking which sovereign bonds are even worth holding? The ones that are up towards one per cent perhaps still have a role in the portfolio but anything that is negative right now, it’s going to be really hard to justify holding that in the portfolio,” he said.

Liquidity will be “everywhere” coming out of the recessionary pandemic environment, Fishers says, and central banks will continue to make cash uncomfortable to hold.

“You’re going to increasingly see cash deployed rather than more and more cash being hoarded by investors,” he said. “Fighting central banks is typically not a great strategy so we’re not really enamoured with cash.”

Bonds are still on the table for Sunsuper, he explained, but the fund will be looking outside the box next year. That means scouring for emerging market and high yield sovereign bonds that are “a little closer to investment grade”.

He called out researchers for not including these investments in their purview, and challenged them to cast more of an eye over assets that don’t fit so easily into growth or defensive categories.

“One of the challenges I think researchers have faced historically in our engagement with them is a certain reluctance to use what we call mid-risk assets,” he said. “There’s a range of things in our portfolio that we find fit somewhere between growth and defensive assets.”

Fisher was joined on the panel by Evergreen Consulting director Angela Ashton and Blackrock head of analysis for APAC, James Kingston.

Ashton agreed that the post-pandemic investment landscape will offer an entirely different vista. Even as we come out of a recession, she explained, irrational exuberance will be curtailed.

“Return expectations have to be ratcheted down; I don’t think anybody believes bonds can provide the absolute returns that they have in the past and certainly cash can’t,” she said. “Whether equities do or not is a much more difficult question because valuations potentially can become much higher as cash and bonds are so low. Its difficult but I think most analysts do believe that returns from here on in are likely lower as a general rule than they have been in the past.”

Kingston took a slightly more bullish outlook, noting that Australia is much better placed than many other developed nations to stage a strong economic recovery.

“We’re sitting in an economy with pent up demand,” he said. “People are itching to get out so there’s a significant possibility that our economy will accelerate more than the US and Europe. So putting that together… Australia is attractive.”

Tahn Sharpe is a Sydney-based financial services journalist with a background in financial planning. He writes on advice, superannuation, investment, banking and insurance issues, is a certified SMSF Adviser and holds an Advanced Diploma of Financial Planning.
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