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Our investment professionals share and challenge each other’s views, creating a diverse marketplace of ideas for the Wellington Blog.

Our ESG philosophy for short-duration investing

Environmental, social, and governance risks have always been key considerations in our research and investment process. These factors are particularly critical given the core objectives of a short-duration portfolio: to maximize liquidity and preserve capital while achieving attractive total return.

Importantly, adverse ESG factors increase the risks of credit deterioration and illiquidity. We believe that there are areas where these risks are not currently compensated by valuations. In our view, heightened global scrutiny of issuers from an ESG lens will eventually drive up the cost of capital for many issuers with outsized ESG risks. In addition, we think it will potentially lead to lower liquidity in their bonds as more investors avoid these issuers. As an example, the tobacco sector already has a higher cost of debt and less demand for issuers on average versus…

Many investors are increasingly seeking to protect their portfolios from the looming threat of higher inflation. Against this uncertain backdrop, I believe collateralized loan obligations (CLOs) can provide one source of refuge given their floating-rate coupons (yields), which would rise as short-term interest rates moved higher. Attractive current income relative to other credit assets and broadly positive CLO fundamentals further bolster my conviction in this often-overlooked asset class.

Where I stand on the inflation debate

Core US inflation spiked sharply in April and May 2021. For the three-month period ended in May, the Consumer Price Index (CPI) rose by 8.3% annualized, the biggest gain since the early 1980s. This has naturally exacerbated recent inflation concerns, raising questions around whether higher inflation will be transitory or more sustained. US interest rates have risen amid expectations for higher inflation, resulting in negative total returns year-to-date (through 31 May) for many fixed income sectors, especially longer-dated fixed-rate assets.

My take: While some of today’s inflationary pressures may indeed be short-lived, particularly within…

MARKETS
THEMES
Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston

In our last blog post in March, we recommended a slightly defensive risk posture for high-yield investors, with a focus on individual security selection. In our view, today’s high-yield bond market requires a carefully balanced approach. We remain selective with a modestly defensive risk tilt given rich valuations, while recognizing that low spreads may last longer thanks to ongoing monetary and fiscal support. We will watch for signs of central banks tightening or deteriorating liquidity before turning more defensive.

Macro environment: Positive

  • At the time of writing, short-term economic data and corporate earnings are as good as it gets, thanks to the stimulus. We expect a modest slowdown into the second half of 2021.
  • Inflationary pressures are building across both emerging markets (EM) and developed markets (DM), with price rises potentially spilling over from goods into services. Policymakers view these pressures as a transitory phenomenon, but we will monitor to determine whether they prove more enduring.
  • We are concerned about these dynamics and…
MARKETS
Christopher Jones
CFA
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

For fixed income investors, varying the amount of credit risk in your portfolio can exert a major influence on the portfolio’s realized alpha. Indeed, historical data shows that this single factor can have a larger impact than decisions around what bond sectors or individual issuers to invest in. Accordingly, it’s worth spending some time thinking about precisely how much credit risk to take and when. My latest research in this area focuses on the role that valuation can play in adjusting credit risk over an economic cycle.

Methodology at a glance

I looked at the strategic timing of buying and selling credit exposure (in the form of corporate bonds, using cash or US Treasuries as a funding source) with low turnover, and using market valuation as the sole buy/sell signal. There are, of course, other predictive drivers of credit returns, such as…

MACRO
MARKETS
Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

Since January 2021, many investors have come around to the view that the US appears poised for a strong rebound in economic growth, driven by fiscal stimulus, vaccine administration, and economic reopenings. Meanwhile, bottlenecks in global supply chains have made it more challenging to meet increased demand for goods and services, causing input costs to rise across a number of industries.

Taken together, these developments have led to mounting inflation expectations and upward movements in interest rates. Year to date through 12 April 2021, the 10-year US Treasury yield has risen 75 basis points (bps) to 1.67%. The spread between the fed funds rate and the US 10-year Treasury note, a general proxy for yield-curve steepness, is also up meaningfully.

I believe the risk of further rises in inflation expectations and interest rates is not yet fully priced into markets. There are steps fixed income investors can take now to manage this growing risk to their portfolios. One way to do so may be via allocations to higher-income, shorter-duration assets such as floating-rate loans (FRLs).

The “duration rotation” is underway

In today’s low-yield world, a steepening yield curve can have a material negative impact on…

MARKETS
THEMES
Dave Marshak headshot
David Marshak
Fixed Income Portfolio Manager
Boston

In our last blog post, we described the secular forces that we believe are driving the transition to a new fixed income reality characterized by more frequent market dislocations. Here, we lay out four steps investors can take to build a new fixed income allocation that is equal to today’s challenges and opportunities.

1. Rethink how to construct a fixed income allocation.

It’s best to start with what we know has changed. We know that inflation may be poised to rise in many countries, which could have important implications for global currencies and interest rates. We know also that the fixed income markets have evolved to become increasingly…

In our view, convertible bonds (“convertibles”) are a compelling investment opportunity in today’s volatile, uncertain market landscape. Due to its hybrid stock/bond nature, the asset class can participate in long-term equity market upside, while delivering much better downside protection than stocks.

Given that nearly 70% of convertibles are unrated securities, we believe a global investment manager with integrated equity and fixed income research platforms is best positioned to navigate this attractive but often inefficient asset class.

1. Exposure to “growthy” companies

The composition of the convertibles universe is “over-indexed” to growth companies, especially in…

MARKETS
Michael Barry
Michael Barry
Fixed Income Credit Analyst
Boston
Raina Dunkelberger
Raina Dunkelberger
CFA
Investment Specialist
Boston

With global high-yield spreads still quite tight as of this writing, we continue to suggest that investors pursue a slightly defensive risk posture and focus on individual security selection. At the same time, investors should maintain flexibility to position nimbly and opportunistically in response to changing market conditions — because we expect greater frequency of short-term market sell-offs going forward.

Macro environment: Positive

  • In the near term, we have a more favorable view of the prevailing macroeconomic tailwinds than we did in the fourth quarter of 2020.
  • Medium to longer term, we have growing concerns around the risk of US Federal Reserve (Fed) “tapering” rhetoric and its potential impact on risk assets.
  • Accommodative fiscal policy has helped bolster corporate balance sheets, which is an unusual characteristic of a post-recession economic recovery.
  • Increased money supply and stockpiled savings could be…

 

MARKETS
Christopher Jones
CFA
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London
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