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

In recent years, nearly every asset owner I have spoken with has had questions about their fixed income allocations: With yields as low as they are, can a traditional fixed income allocation still serve as an “all-in-one” diversifier? Should I be worried about risks in the credit market? What role should alternatives play in filling gaps in my portfolio?

The pandemic only added to the questions. It created an unusual level of disruption in capital markets, leaving diversification, the bedrock of strategic asset allocation, in short supply. At the same time, asset owners have had to contend with unprecedented market narrowness and structure issues, and the risks of monetary and fiscal policy experiments. And the likelihood of continued low yields (despite the recent uptick) suggests that traditional fixed income will struggle to produce the total return that many have come to expect and may offer less protection from volatility. While I still see a role for government bonds as ballast, I think complementary allocations need to be considered.

An alternative path to diversification

For many asset owners, the first option that comes to mind is private credit. But while private credit may well support return-seeking objectives, I don’t think it does much to…

MARKETS
Cara Lafond
Cara Lafond
CFA
Multi-Asset Strategist
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…

Most of the past decade-plus has been characterized by declining interest rates and tightening credit spreads. Against this backdrop, many traditional fixed income benchmarks have performed well, particularly those with longer durations and meaningful credit components.

However, we believe 2021 could mark a transition to a new fixed income reality wrought by ongoing structural changes, potentially leading to more frequent dislocations across market sectors. Here we describe the secular forces that we believe are driving these changes, to be followed by a proposed solution for fixed income investors in our next blog post.

Structural shifts in consumer behavior

The COVID-19 crisis has driven increased adoption of technology and structural shifts in consumer behavior, some of which are…

MARKETS
Emily Bannister
Emily Bannister
CFA
Investment Director
Boston
Richard Gilmartin
Rich Gilmartin
Investment Director
Boston

When Janet Yellen was confirmed as US Treasury Secretary in January 2021, questions inevitably resurfaced as to whether the Treasury should begin issuing a 50-year or even a 100-year ultralong note.

Just a few years ago, the Treasury’s debt managers, in consultation with the Treasury Borrowing Advisory Committee (TBAC), reviewed the potential issuance and concluded that it would not meet the Office of Debt Management (ODM)’s mandate of financing the government at the lowest possible cost of debt. Moreover, an ultralong note would present a challenge to the Treasury’s goal of “regular and predictable” issuance.

My purpose here is not to advocate for or against ultralong issuance, but rather to…

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

The transition to the “sunsetting” of long-standing LIBOR benchmarks — initially slated for 31 December 2021 — has been fraught with delays and uncertainty, thanks in no small part to the ongoing COVID-19 crisis. There has been progress, however. A number of recent developments reinforce the commitment by regulators and central banks to wean market participants off their reliance on IBORs (interbank offered rates) and to embrace alternative reference rates.

The UK FCA announcement

  • On March 5, the UK’s Financial Conduct Authority (FCA) officially announced the eagerly anticipated cessation and non-representation dates on 35 LIBOR benchmarks across various tenors and…
MACRO
Matthew House
Matthew House
Fixed Income Portfolio Analyst
Boston

“Isn’t value investing more of an equity market concept?”

The short answer is no. While it’s a legitimate question (and one we’ve gotten quite accustomed to hearing), the reality is that both equity and fixed income market participants are often drawn to “cheap” assets by the allure of enhanced excess return potential. Here is some of my team’s latest thinking on value investing and why we think it’s relevant in credit markets.

What exactly is “value” investing in credit markets anyway?

For years, many fixed income investors have adhered to pretty loose definitions of what constitutes an overvalued (“expensive”) or undervalued (“cheap”) credit asset, typically based on whether its option-adjusted-spread is wide or tight versus a given risk-free asset (e.g., US Treasuries).

Our investment framework goes a step further with a more nuanced approach to the notion of “value” in corporate credit markets. We follow a…

MARKETS
THEMES
Brendan Fludder
CFA
Research Manager
Boston
Carlos Coutinho
Carlos Coutinho
CFA
Solutions Portfolio Manager
Boston
Noah Comen
Noah Comen
CFA
Investment Strategy Analyst
Boston

Interest rates have been rising since August 2020, with the yield on the 10-year US Treasury bond having drifted 100 basis points (bps) higher over the past six months or so. But recent rate action has really caught the market’s attention, particularly the 10-year yield’s swift 30 bps increase and the spillover into global equity markets.

Is the latest bout of “rate repricing” due to higher inflation expectations? Stronger economic growth? Treasury supply issues? “Fed fighting”? Let’s try to make sense of it all.

Yields have risen for the right reasons — Rates have been adjusting to prospects for better growth and higher inflation for months now, reflecting an improving pandemic outlook and ample policy support. Rising inflation expectations are baked into wider spreads between Treasury yields and real (inflation-adjusted) yields, using 10-year Treasury Inflation-Protected Securities (TIPs) as a proxy. Orderly rate moves have been absorbed by…

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

In my 2020 insight, “Debunking four common myths about CLOs,” I highlighted what I saw at the time as compelling value in several tranches of the collateralized loan obligation (CLO) market. Looking at recent CLO spreads and valuations, I believe that remains the case as of this writing.

CLO spreads rebounded quickly from last year’s COVID-19-induced sell-off. Despite spread tightening across the capital structure over the past year, I still find CLOs attractive versus competing asset classes, such as corporate credit (Figure 1)…

Figure 1

CLO spreads vs corporate credit spreads

…especially in light of my positive outlook for CLO fundamentals. As the market has recovered, the underlying bank loan collateral credit metrics have…

MARKETS
Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston
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Baseball legend Yogi Berra famously remarked that “it’s tough to make predictions, especially about the future.” Political elections are no exception, of course. But as difficult as forecasting an election can be, predicting market reactions is arguably even more challenging. That being said, with the 2020 US elections only a few weeks away, now seems an opportune time to think through the various potential outcomes and their implications for fixed income and currency markets.

While most market participants are focused on the presidential election, which party controls the Senate is of equal importance in the event of a Biden victory; it matters less under a Trump presidency given that Democrats control the House of Representatives, with little chance of a flip there. Thus, the three possible outcomes to consider are…

MACRO

ARCHIVED

Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston
Joe Marvan
Joseph Marvan
Fixed Income Portfolio Manager
Boston

The US hospital sector saw a substantial direct impact from COVID-19, primarily via the sharp decline in elective medical procedures, but also received significant aid from the Coronavirus Aid, Relief, and Economic Security (CARES) Act. So what now?

Ultimately, the performance of hospitals — and the municipal bonds (munis) they issue — will depend on the severity and duration of the current health crisis. We expect diminished revenues for the remainder of 2020, although many hospitals are cutting costs and deferring capital spending to help offset this. We believe hospitals with strong balance streets and fundamentally viable operations are best positioned to weather the crisis; for weaker hospitals, ratings downgrades are likely.

The current condition of hospitals

Coming into the pandemic, financial performance across the US hospital sector was largely stable. Most health care providers were managing through various sector headwinds, thanks to…

CORONAVIRUS
MARKETS

ARCHIVED

Jennifer Soule
Jennifer Soule
Fixed Income Credit Analyst
Boston

The term “fallen angels” has always carried a somewhat pejorative connotation among fixed income investors. In some instances, that may well be justified, but not always. Indeed, particularly in today’s environment, I believe discerning investors may be able to uncover attractive value in the often-scorned universe of fallen angels.

Lay of the land

  • Fallen angels are formerly investment-grade-rated corporate bonds whose ratings have been downgraded to high yield (i.e., below investment grade) by major rating agencies.
  • Within two years of being thus downgraded, fallen angels as a group have meaningfully outperformed the broader high-yield index and all three quality subgroups (Figure 1).
  • Some of fallen angels’ excess return versus the index was attributable to…
MARKETS

ARCHIVED

Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

European, global, and US high-yield indices declined around 20% from the start of the year through the peak in spreads on March 23. However, extraordinary global monetary and fiscal stimulus measures in response to the COVID-19 crisis have since helped high-yield markets recoup a sizeable portion of those losses. Members of Wellington’s High Yield Strategy Group met recently to discuss their market outlook, including perceived risks and opportunities, in the wake of this extreme volatility.

Economic data buoyed by stimulus

While the worst of the economic shock is likely behind us, the question now surrounds the trajectory and timing of a recovery. Our base case is for a two-stage recovery that begins with a strong rebound from pent-up consumer demand as lockdown measures are eased, followed by a drawn-out recession.

Purchasing managers’ indices (PMIs) — economic indicators derived from surveys of private companies — remain depressed across nearly all geographies. However, we believe…

CORONAVIRUS
MARKETS

ARCHIVED

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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