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Our views 25 January 2021

JP’s journal: Value investing in fixed income?

5 min read

As well as changing spending patterns Covid could also be said to be changing the way we invest. Last week Peter Hargreaves was reported as saying Value investing is dead. At an equity level it may be hard to argue given the structural shifts going on – but from a fixed income perspective it’s very different.

Yes, economies and markets are changing but the risk / reward profile for credit is very different from equities. Increasingly, some sectors in credit are falling out of favour and others are benefiting from the perception of being in the right areas or demonstrating strong sustainability features. This is pushing up financing costs in the former and reducing them for the latter group. This is sensible for credits with a long-term horizon but it creates opportunities for shorter dated credits where the risk may be overstated. Value investing is not dead in fixed income. 

Economics and markets

UK Retail Sales for December were weak – perhaps not a great surprise given lockdown. More interestingly the data showed: (1) retail sales are above pre-crisis levels and (2) the acceleration of the structural change in sales composition, with online retailing increasing by 46% in 2020 and clothing stores seeing a 25% decline. Covid is massively accelerating changes in how we spend.

Global data was mixed: US industrial output was OK but retail sales disappointed whilst the US Fed’s Beige Book, a summary of US economic conditions, was seen as being on the soft side.

The new US President wasted no time in reversing some of President Trump’s policies, via a slew of Executive Orders. However, investors may be over egging the flexibility that President Biden has – the Senate is evenly split and the House only has a narrow Democrat majority – compromise seems a more likely way forward to me. What does that mean for policy? Perhaps not such an expansionary fiscal policy as first thought, although the implementation of a minimum wage of 15 USD per hour would put a lot more spending power in consumers’ pockets. We shall see if President Biden gets his way.

Cash, currencies and government bonds

Again there was little change on the week in cash markets with 3 Month GBP LIBOR edging a bit higher to 0.035%. Currencies showed no big moves with the £/$ rate ending just below 1.37. I have been surprised how resilient sterling has been in recent months. This rate is probably more a reflection of USD weakness than confidence in the UK economy.

It was not an exciting week in government markets: ten year US rates were broadly unchanged at 1.08% ten year UK gilt yields rose to 2 bps to 0.31% whilst Germany yields remained at around -0.5%. I still prefer US markets - both conventional and real – to alternatives out there. Recent  weeks have seen commodity prices move higher – this being particularly pronounced in some agricultural commodities – and I do expect global inflationary pressured to pick up as economies bounce back from lockdowns. However, I am not yet an inflation bear and see enough headwinds to economies going forward to keep inflation under control in the medium term.  

There were some interesting comments from Paul Tucker (ex Deputy Governor of the Bank of England) last week that are well worth checking out. He is cautioning about the efficacy of renewed QE, the dubious merits of negative interest rates and the importance of central banks maintaining their independence from governments. This latter point has been emphasised by my colleague Craig Inches: credibility is vital.

Credit

A quiet week in sterling credit, with investment grade non-gilt credit spreads staying broadly unchanged at 95 bps. New issuance was subdued but we continued to see a flow of bonds that emphasized their ESG / Sustainability credentials. A good example (Euro not Sterling – I admit) was the 750m 0.375% 2029 Tesco bond. The bond is aligned to an agreed Sustainability Performance Target (SPT) of reducing Scope 1 and 2 Group Greenhouse Gas (GHG) Emissions by 60% by 2025 against Tesco’s 2015 Baseline. I prefer the sterling secured debt which we hold extensively in our sterling credit strategies.

Global investment grade credit was also pretty flat over the week and high yield made a bit of progress. New issuance is keeping the high yield team busy: we bought bonds issued by the AA and Ineos Quattro – the latter a leading global chemicals company with sales of over $60bn. We continue to look for opportunities in emerging market credit – where exposure across our strategies is increasing.

I see opportunities in high yield – although the fall in credit spread from the 10% in March to a current level of 4% has to be acknowledged. Azhar Hussain, who heads our Global Credit team, points out that low financing costs and covenant flexibility will allow the corporate sector to cope with the present crisis much better – with lower defaults – than many would have expected.   

For professional clients only, not suitable for retail investors.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.