IN FOCUS6-8 min read

Fixed income shines in turbulent times

The economic disruption wrought by the coronavirus has stopped the global recovery in its tracks, prompting a rapid response from central banks. Yet while there are still downside risks to be fully priced in by nervous markets, high-quality fixed income continues to prove a valuable hedge against equity risk and a preserver of capital in turbulent times.

11/03/2020
AdobeStock_272310763_resize

Authors

Kellie Wood
Deputy Head of Fixed Income

For some time now, we have been concerned about extended valuations in risky markets, but unsure of the catalyst for a major repricing. February brought just this catalyst, with coronavirus fears leading to a sharp fall in both equity prices and bond yields.

The speed of the decline in bond yields has been nothing short of stunning and has provided investors with strong returns (even at low yields). High-quality fixed income is once again proving to be a great hedge against equity risk, over short term timeframes in most circumstances.  

The rest of the world was slow to recognise the danger coronavirus posed beyond China. As well as the tragic human impact, the economic disruption is likely to be intense, with both supply and demand curtailed. The outbreak of the virus has stopped the global recovery in its tracks. Business surveys suggest global growth will be very weak in Q1, with a contraction possible.

Racing towards the zero lower bound

Faced with this huge shock, central banks are back easing policy, with the US Federal Reserve implementing the first inter-meeting 50bps cut since the GFC in early March. The primary question for markets is whether the coordinated unleashing of global monetary accommodation is decisive in reversing the sharp downside risks that are being priced into markets – the historical evidence and details of the current risks are not encouraging.

We are in unchartered territory, as the current threat to the global cycle is not a phenomenon of financial nature (as it was in the 2007/08 episodes). US Fed Chair Powell himself acknowledged this in a recent press conference, stating that “we do recognise a rate cut will not reduce the rate of infection and won’t fix a broken supply chain.”

It is no secret that the US has more room to cut than other central banks. A return to the zero lower bound must now be considered among the Fed’s appropriate policy responses to the outbreak. This raises some concern, as the scope for central banks to cut rates is limited, and rate cuts are not necessarily the right policy response to what’s happening now. Governments struggling to contain the global economic fallout from the coronavirus outbreak face mounting calls to unleash a major fiscal stimulus that could help cushion the blow. To be effective, such fiscal support needs to be targeted to provide cashflow relief for companies in order to limit bankruptcies.

Australia is one of the most exposed countries to weaker Chinese demand. The RBA, in cutting the cash rate in early March to 0.5%, clearly felt that the growing risk to the Australian outlook warranted decisive and early action. This all comes at a time when the backdrop for Australia is one of weak growth, low inflation and lack of momentum in the jobs market. A fiscal response has become more likely but could be very underwhelming. We expect the RBA to take the cash rate lower to the effective lower bound and most likely implement QE.

Our portfolio position

We entered February with duration longer than benchmark by about 0.50 years, but increased this materially to be 1.20 years long at the time of writing. Our preferred exposure is in US Treasuries, both because the Fed can ease by more than other central banks, and because Treasuries are a safe haven in uncertain times. We also have small long positions in Australia and Canada. We continue to hold inflation linked bonds on valuation grounds, although these are likely to continue underperforming in the near term with the collapse in oil prices.

For credit, the cashflow shock has clear negative implications for corporate profitability and is likely to increase the risk of financial distress for the low end of the quality spectrum. We remain short global high yield. We predominantly hold high-quality Australian investment grade credit, but have pared back our exposure considerably. Australian mortgages remain attractive, both on relative valuation to corporates and as a diversifier to corporate credit exposure. We also maintain our allocations to US mortgages and emerging market debt, seeking to diversify both income and risk sources.

Overall, the portfolio retains it long duration and high-quality focus, placing a priority on preserving liquidity, meaning we are well-placed to weather these turbulent times.

Learn more about the Schroder Fixed Income Fund.

Important Information:

This document is issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders). It is intended solely for wholesale clients (as defined under the Corporations Act 2001 (Cth)) and is not suitable for distribution to retail clients. This document does not contain and should not be taken as containing any financial product advice or financial product recommendations. This document does not take into consideration any recipient’s objectives, financial situation or needs. Before making any decision relating to a Schroders fund, you should obtain and read a copy of the product disclosure statement available at www.schroders.com.au or other relevant disclosure document for that fund and consider the appropriateness of the fund to your objectives, financial situation and needs. You should also refer to the target market determination for the fund at www.schroders.com.au. All investments carry risk, and the repayment of capital and performance in any of the funds named in this document are not guaranteed by Schroders or any company in the Schroders Group. The material contained in this document is not intended to provide, and should not be relied on for accounting, legal or tax advice. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. To the maximum extent permitted by law, Schroders, every company in the Schroders plc group, and their respective directors, officers, employees, consultants and agents exclude all liability (however arising) for any direct or indirect loss or damage that may be suffered by the recipient or any other person in connection with this document. Opinions, estimates and projections contained in this document reflect the opinions of the authors as at the date of this document and are subject to change without notice. “Forward-looking” information, such as forecasts or projections, are not guarantees of any future performance and there is no assurance that any forecast or projection will be realised. Past performance is not a reliable indicator of future performance. All references to securities, sectors, regions and/or countries are made for illustrative purposes only and are not to be construed as recommendations to buy, sell or hold. Telephone calls and other electronic communications with Schroders representatives may be recorded.

Authors

Kellie Wood
Deputy Head of Fixed Income

Topics

Our sales team is available to discuss with you any investment opportunities.
Follow us

This website is owned and operated by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473).  Your access to this website is subject to the Terms of Use found by clicking the ‘Important Information’ link below.  By using this website, you agree to be subject to these Terms of Use.