Broad based regime changes are taking place in global economic thinking, giving fixed income investors a new world in which to operate.
Paul Brain (main picture, left), head of fixed income at Newton Investment Management, says traditionally, free markets have governed policy discussions. He points to Washington DC, and institutions like the World Bank, the IMF and the US Treasury which have sorted out underperforming economies using free markets, small governments and monetary policy that stimulates growth.
But Brain says there’s a definite move towards rebuilding and steering economies in a new direction, rather than just managing through a crisis.
“The shift towards populism means governments are getting elected on the promise of spending more money to create a better economy,” Brain says.
“This increased role of government in economic policies will lead to larger deficits.”
Central banks have accommodated this change and are supplying governments with financing through quantitative easing, ultimately leading to the erosion of free trade and the reversal of the globalisation theme.
“We’re seeing gradual shifts accelerating away from the power of capital to the power of labour, fuelled a lot by the gig economy,” says Brain.
“This is now being tested through regulation, better pay for employees or maybe the move towards a universal basic income.”
This kind of economic thinking has significant implications for fixed income investors, namely the fixed income bull market that’s been in place for forty years is coming to an end, Brain says.
The desire for central banks to run a higher inflation rate for longer, and move away from disinflation, means fixed income is taking on a new role in people’s portfolios.
“A mixture of equities and fixed income has worked really well, but fixed income might become a safe haven that’s costing you money,” Brain says.
Rising government bond yields means there will need to be another way to hedge portfolios and this has broad implications for equity valuations.
One profound use Brain sees for the bond market, is through the profound ESG prism through which investing is increasingly seen.
“We can actually use the bond market to be a better allocator of capital towards change and governments are fully behind this,” Brain says.
The rise of sovereign issued green bonds, and other bonds that service social connection between people are prompting the corporate sector to issue transition bonds to finance their own decarbonisation plans and better transform their businesses to a wider range of stakeholders.
One hundred and sixty-six billion dollars of ESG focused debt was issued in the fourth quarter of 2020, and 50 per cent of the issuance in 2021 so far has been in the form of green, social or sustainable issuance, Brain says.
When it comes to opportunities, Brain points out there are different types of infrastructure spend across the world that aligns with different types of monetary policy. It’s this divergence between fiscal and monetary policy offers valuable investment possibilities.
As it stands, Newtown is looking more towards credit rather than sovereign debt.
“This is purely because corporate profits will do well over the next couple of years, and this makes the debt they have more serviceable,” Brain says. “Government bonds are more linked to government yields which are more linked to the potential inflation coming, so we’d prefer to be short government bonds and long credit.
“We think that’s going to be a useful trade over the next sixth months or so.”
Jeff Klingelhofer (main picture, right), co-head of investment, global fixed income and managing director at Thornburg, says the volatility in credit markets offers a good opportunity for sophisticated investors to enter.
“Private credit markets have got another shot in the arm as larger and larger companies are viewing it as a primary source of capital,” Klingelhofer says.
However the onset of the COVID19 crisis was a severe and rapid operational downtime, and the underlying performance and viability of some of Thornburg’s investments was challenged.
“This was much scarier than a financial crisis that can take a long time to build up,” he says.
Targeting dislocated companies or industries during COVID19 proved the most attractive opportunity for investors, but Klingelhofer says private credit is most often used by companies to fund some sort of acquisition.
“Whether that’s a leveraged buyout in a company or a management team to fuel growth, there are many different reasons why,” he says.
But the reason companies come to private credit is it’s a much easier, smoother process than through traditional financing channels.
“You don’t need to go out and do a roadshow, and we don’t need to get our debt rated, and there’s generally just less management distraction,” he says.
“We also develop relationships with these companies, so we tend to be more rational and sophisticated during difficult times.”