Fidelity Multi Asset Income Team - Eugene Philalithis, George Efstathopoulos, Chris Forgan
We are yet to see this extent of recovery in fundamentals for equities and dividend payments, and while earnings have generally been better than expected across regions and sectors, there is the risk that they could stall from here. In contrast to equities, the rally in credit markets has a healthier spread, where the narrowly led nature of the equity market indicates fragility, acutely seen for US equities.
It’s no secret that both equity and credit markets have seen a strong recovery after the aggressive sell-off to their March lows, and the bleak economic data that followed. We have seen a liquidity-driven rally through which credit especially has staged an impressive recovery. Against this backdrop, we have maintained our bias for credit risk over equity risk and continue to focus on assets further up in the capital structure for income security and capital preservation. In particular, high yield bonds and emerging market debt (EMD) in hard currency are two key areas of conviction that we have been adding to over recent months.
Regionally, we see Asia as favourable compared to other regions - both under the base case scenario and in terms of the upside/downside ratio, although we are starting to become more constructive on other regions. Valuations also continue to be attractive given spreads remaining high versus their historical ranges, and importantly, the boosting of yields supports income sustainability.
Within high yield, our preference for Asian high yield has persisted over recent months due to a number of factors including Asian companies having reduced debt on their balance sheets, supportive funding conditions. The domestic focused nature of the Asia high yield universe also offers some insulation against any sustained trade war resurgence. However, we are now moving towards a more constructive view on US and European high yield, which we think offer a more attractive risk-reward against their respective equities. The fundamental outlook for EMD has improved with the re-opening of the world’s major economies, upward oil price trend and the scale of IMF support. We, therefore, continue to rotate from EMD local currency to hard currency due to its attractive valuations, defensiveness relative to local currency EMD, and more upside participation in oil markets.
Of course, inherent risks remain within credit - particularly amongst the most challenged emerging market issuers, which have a lack of fiscal headroom to continue quantitative easing over a prolonged period - and so when we evaluate credit asset classes, the downside scenarios are interrogated closely. Overall, after a strong rally, our preference for credit over equity risk is still intact. However, a more finely tuned credit asset allocation is needed as the risk-return asymmetry is more attractive in certain areas of credit than others. We believe that a multi asset approach that can allocate flexibly across the spectrum of income paying assets, and navigate the caution required around various credit assets, makes our income-focused strategies well positioned to deliver on their objectives.
