#WellSaid

The Wellington Blog — A diverse marketplace of ideas, where our investment professionals share and challenge each other’s views. They decide independently how to draw on those ideas to sharpen their investment decisions, unconstrained by any single “house view.”

Sustainability, in all its forms, is a strategic priority for our firm and an integral part of our long-term mindset and commitment to our clients. We believe sustainable investing will shift capital markets over the next 20 years, and our goal is to drive excellence for clients by building a sustainability edge that is research based, credible, and future facing.

During 2021, we made significant investments to bolster our sustainable investing and operational efforts, including expanding our team of professionals and strengthening our leadership and governance ecosystem. We continued our research on the potential impacts of climate change on markets, economies, and the investment portfolios we manage on behalf of our clients. Throughout the year, we expanded our constructive dialogue with companies and issuers. Emphasizing management accountability, we tracked and achieved favorable engagement outcomes on major priorities, including strengthening climate resilience, addressing board diversity, and aligning…

 

SUSTAINABILITY
Wendy Cromwell
Wendy Cromwell
CFA
Vice Chair, Head of Sustainable Investment
Boston

Among investors pursuing long-term objectives like retirement, there is an understandable tendency to focus on the accumulation of assets. But as populations around the world age and need to tap into accumulated wealth, there will be a growing interest in sound decumulation practices — a complex investment challenge and the subject of a recent research project we conducted.

The path-dependency effect

A decumulation strategy must support regular withdrawals from a portfolio regardless of the performance of the underlying investments. Unless the strategy generates a sufficient return, withdrawals will eventually erode the capital below a desired amount or completely (longevity risk). Even if the return is equal to the withdrawal rate, erosion could occur, as the return replacement process is affected by path dependency (or sequencing risk), which is in turn determined by the interaction between…

THEMES
Samouilhan_Nick
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore
Alex King
Alex King
CFA
Investment Strategy Analyst
London
Jacqueline Yang
Jackie Yang
CFA
Investment Strategy Analyst
Boston

Fixed income investors just experienced a “once-in-a-career” market correction: a 10% decline in the Bloomberg Barclays US Aggregate Bond Index (the “Agg”) through the first four months of 2022. For most allocators, this sharp downturn came in tandem with a painful equity market sell-off that has produced a -15% return for the S&P 500 Index year-to-date. It’s been rough sledding for traditional assets so far this year.

The forces behind the fixed income correction are by now familiar to market participants: rising interest rates, triggered largely by higher and stickier inflation than expected, and a scramble by the US Federal Reserve (Fed) to play “catch up” — in other words, to rein in inflation before a vicious cycle of surging wages and even higher prices takes hold. What now? I’m still hesitant to call a “top” for how high 10-year US rates might climb (beyond 3%) because the trajectory of future inflation remains highly uncertain, but I see tentative signs that we may be nearing a plateau. Below are four considerations that have me leaning…

MACRO
MARKETS
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

As we explored in our last blog post, Helping European investors navigate inflation fears, the current market environment presents challenges for fixed income investors. Chief among them: rising interest rates. Against this backdrop, rather than simply take a portfolio’s effective duration1 at face value, we encourage investors to consider a multitude of factors when deciding how best to allocate their fixed income capital. One such factor is that of empirical duration, which (as opposed to effective duration) calculates a bond’s sensitivity to rising rates based on historical data versus using a preset formula.

Understanding portfolio duration

As global central banks take steps to tackle inflation, a variety of monetary policy responses remain possible throughout the remainder of 2022. Figure 1 highlights three hypothetical scenarios.

FIGURE 1

Possible monetary policy scenarios with potential impact on fixed income returns

From a purely theoretical standpoint, the concept of duration implies that all non-floating-rate fixed income portfolios will suffer…

MARKETS
Will Prentis
Will Prentis
Investment Analyst
London
Tobias Ripka
Tobias Ripka
CFA
Investment Director
Frankfurt

With the US Federal Reserve’s (Fed’s) interest-rate-hiking cycle now underway, it’s an important time to keep a close eye on non-US buyers of US dollar (USD) fixed income securities. Historically, Japanese and European investors have been large participants in the space. But if the Fed continues to raise US rates as expected, the positive carry return1 that these investors have recently reaped from US Treasuries may turn negative because the Fed’s rate hikes will increase the cost of foreign-exchange hedging for non-US investors, particularly in Japan. Indeed, taking account of currency hedging, European fixed income could start to look more attractive than its US counterpart to Japanese buyers.

Figure 1 shows the spread of hedged 10-year US Treasuries versus 10-year Japanese government bonds (JGBs) in light blue and the spread of hedged 10-year German bunds versus 10-year JGBs in dark blue. Both lines use a 12-month currency forward, instead of the more commonly used three-month forward, to better incorporate the…

MACRO
MARKETS
Amar Reganti
Amar Reganti
Investment Director
Boston
Pontoriero, Pasquale
Pasquale Pontoriero
CFTC
Fixed Income Portfolio Manager
Boston

Numerous positive structural and cyclical factors are pointing towards a major economic upcycle in India over the next five to six years, in our view, creating a range of potential investment opportunities. We believe India’s market is supported by an evolving investment universe, powerful demographic trends, increasing urbanisation and rising wealth, export growth, geopolitical tailwinds and a supportive policy regime. These factors are coalescing at a time when the corporate deleveraging cycle of the last few years is coming to an end and a new upcycle in profitability could be beginning.

1. A shifting investment landscape

The investable landscape in India is in the process of transforming, in our view, with more internet, media and e-commerce businesses likely to come to market over the next two to three years. These industries currently make up less than 1% each of the MSCI India Index, compared to 16% – 18% each in the MSCI China Index (Figure 1).1 We believe the companies starting to list in public markets in these sectors will provide a…

MARKETS
THEMES
Philip Brooks
Philip Brooks
CFA
Investment Director
Singapore

While many asset owners recognize the value of a long-term mindset, it can be challenging to resist short-term instincts in volatile environments like the one we’ve seen in recent months. But asset owners who have a strategy to help them stay focused on the long term may avoid a number of potentially costly behaviors, including abandoning a thoughtfully selected allocation to a manager after a relatively short period of underperformance.

Signs of resilience in top-quartile managers

Our research shows that even the best managers have had to bounce back from periods of underperformance. Recently, for example, we used the eVestment database to look at the performance of active managers in the global core equity universe who had at least a trailing 10-year history (331 managers, 2012 – 2021). We evaluated their peer-universe-relative 10-year excess return rank (calculated using the MSCI All-Country World Index) to identify the top-quartile…

MARKETS
THEMES
Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston
Morgan Cappetta
Morgan Cappetta
Competitive Intelligence Specialist
Boston
Meg Henson
Meg Henson
Business Associate
Boston

After years of near deflation across much of Europe, the region is now witnessing persistent price increases. Second-order effects of recent geopolitical developments, particularly the ongoing war in Ukraine, are intensifying the current inflationary environment. This apparent shift to a higher inflation regime, with the resulting expectation of tighter monetary policy and rising interest rates, presents a material challenge for European fixed income investors, raising questions such as:

  1. Should I consider adjusting my portfolio allocations based on higher inflation risk?
  2. What are the most attractive fixed income sectors in an inflationary environment?
  3. Where are there still pockets of value and opportunity in global financial markets?

How best to answer these questions depends on the specific circumstances of each investor, but over the coming months, we aim to share some pointers to help European investors think through the implications of higher inflation for their fixed income portfolios. As a first step, let’s take a closer look at…

MACRO
MARKETS
Will Prentis
Will Prentis
Investment Analyst
London
Tobias Ripka
Tobias Ripka
CFA
Investment Director
Frankfurt
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