Fixed income can still provide protection against downturns and benefit from spikes, but today it is notably harder to come by. You have to be opportunistic. You have to be agile and you have to be solution-oriented.
In our opinion as active managers, the index is not the starting point for allocating capital, but a proxy for risk. It is the measure of how much risk a manager should assume to achieve the solution that has been mandated. Basically the first step is to assign active management a range of action around that index. The goal is not always to be neutral. In times like Covid, you want your fixed income managers to be able to assume a little more risk, and in periods perhaps like the current ones or in a period in which the manager believes that the risk is not well rewarded, that they assume less amount.
The return / risk equation today is not tilted in favor of investors. It is important to become more defensive in building a portfolio that has lower potential volatility and to look for those areas of the market that are not exposed to a correction, to protect against potential downside.
Risk and return: how to be defensive
1) Be careful with the duration
Our advice is be wary of duration. We continue to look for opportunities to reduce the duration of credit, given the movement of spreads in the last twelve months. Investment grade spreads are now tighter than at the beginning of 2020 (before the correction caused by the Covid) despite the fact that corporate leverage has increased throughout 2020 from levels that were already high. Fiscal and monetary stimuli should continue to support the economy, basically corporate profits and cash flows. Therefore, we are not concerned with exposure; Nevertheless, prices seem to be reflecting much of the economic recovery already. As always, we look for exciting opportunities, no matter what the market environment is. We have recently seen higher quality in maturities of two to five years.
2) Move up the capital structure towards securitized assets when possible
The reality is that markets sometimes reflect notable price differences around niches, and one of those lags was that of global airlines before Covid, when unsecured and securitized corporate debt on the same line were trading higher. of the other. During the pandemic, there was a fairly significant price divergence. One of the referrals fell 70%, while the other fell 40%, that is, 30 cents on the dollar compared to 60 cents on the dollar. Today, it is relatively easy to do these kinds of trades if you can sacrifice 1, 2, 3, 4 or 5 basis points, because at the same time you get a lot of protection by moving to the top of the capital structure and towards securitisations.
Secured credit is another area where we can do this, by withdrawing our credit duration through defensive positioning through individual assets, but also by reducing positions and being more defensive.
Some MBS still look reasonably attractive, especially those for high-quality companies. There are idiosyncratic stories, such as a low coupon and low-exposure mortgage balances that present reasonably stable payment profiles, that make us think that we are being rewarded for taking the risk of convexity.
3) The history of consumption still has potential
We still believe in the history of the recovery of consumption, given the improvement in the labor market in the long term and the stimuli through payments. The Covid recession caught consumers in good financial health and, although the immediate impact of the recession was quite strong, the stimuli through the direct payment of money and the general recovery of the economy have allowed them to recover or maintain a good profile financial.
The places investors should look are where central banks have been remarkably less involved, and that is the world of securitized products.
While residential non-agency-backed (RMBS) ABS and MBS senior tranches have narrowed in line with corporate bonds, we continue to believe that some asset types and programs remain interesting. Senior ABSs are particularly interesting, because the spreads are relatively attractive and the durations are short. Additionally, many of these bonds are being amortized, so we get cash flows every month.
The RMBS market remains attractive due to consumer finance, as well as the strength of the real estate market, which provides collateral for these bonds.
Preparing portfolios for economic changes, volatility and new opportunities
We are rotating some of our portfolios to more conservative positions. Compensation for investing in spreads has decreased notably in the last twelve months. Fiscal and monetary stimuli provide good economic support for credit (much already reflected in valuations), but also provides the basis for inflationary and interest rate movements that can scare, since they could create volatility along the yield curve and in credit spreads. We want to be positioned to take advantage of those opportunities. Accordingly, we continue to preserve liquidity in the form of cash, Treasuries, agency mortgages, ABS with monthly amortization, and shorts on high-quality corporate bonds.
The exit from the global financial crisis of a decade ago saw structural adjustments in the way the global economy was working. Central banks around the world changed the regulatory environment. They became almost commoditized utilities and, to be fair, this is now being put to the test, as we saw with the crash of an Asian hedge fund that we’ve all read about recently.
During the process of coming out of the Covid crisis we are seeing structural adjustments again. Some of the players in debt have collapsed. In order to scale in quality, as measured by ratings from rating agencies, investors need to search pockets of relative value.
In short, as active fixed income managers, we take risk when it makes sense to take it, and we focus on protection against downside when our view is that markets are not well positioned to reward risk taking. In fixed income we play the defensive card 80% of the time, and this is very true today.
Thornburg Investment Management is an independent global investment manager founded in 1982 that offers a range of multi-strategic solutions for institutions and financial advisers around the world. It is a company recognized as a leader in investment in fixed income, stocks and alternative assets that oversees $ 45 billion ($ 43.5 billion in assets under management and another $ 1.8 billion in advised assets) through mutual funds, institutional accounts , separate accounts for individual high net worth investors and UCITS funds for non-US investors (data as of December 31, 2020). Thornburg was founded in 1982 and is headquartered in Santa Fe, New Mexico, USA, with additional offices in London, Hong Kong, and Shanghai.
For more information, please visit www.thornburg.com
–
