It’s clear that inflation (or disinflation) will remain front of mind over the coming months, but what does this really mean for income-seeking investors? Of course, inflation is a challenge to any income-seeking investment strategy. Given the extent of policy action we have seen, our team is cognisant of the risk of rising yields and some inflation in the medium term, and Fidelity’s multi asset income focused portfolios are positioned accordingly to insulate against this. Currently we maintain relatively low duration, both in terms of fixed income and equity sector real duration. For example, we are reducing our US investment grade corporate bond exposure as increased duration has made fundamentals less appealing. While we are mindful of the risk of an inflation-driven back-up in government bond yields, we are comfortable with taking duration risk on Chinese government bonds, which have shown their defensive qualities during the March lows this year, while offering an attractive yield pick-up over developed market government bonds.
We have also been reducing exposure to leveraged loans and instead adding to high yield corporate bonds. Leveraged loans typically see inflows and outperform high yield bonds when Libor is rising or expected to rise. Current Fed policy may therefore render loans structural underperformers compared to high yield over the coming years, as Libor will likely be anchored to very low levels. Meanwhile, high yield credit has benefitted from the Fed backstop, resulting in a resilience over the past month against the equity volatility we have seen.
We’re now at an important inflection point where in practice, our team’s approach to thinking about disinflation is centred on having the conviction to act if and when yields rise, seeing this as a potential buying opportunity to add duration rather than a trigger to play a momentum sell-off in developed market rates.
Overall, we believe that inflation will remain one of the most important stories for investors as we move through the rest of 2020. We are watching the global macroeconomic backdrop closely, continuing to draw on the analysis of Fidelity’s dedicated macro research team to understand its likely trajectory over the coming months. We believe it’s important to position income-focused strategies for a number of disinflationary forces while remaining flexible to adjust exposure in response to any changes in this unfolding picture.
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