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Spread of returns
As the sell-off continues, riskier debt has been given a bit of wiggle room. Unsurprisingly, junk bond spreads that were at record lows have started widening again. But as ever with fixed income, there are still plenty of thorny questions for wealth managers to work through.
The value on offer in the global bond market has been derided for years now, even if 2019 again showed that the doubters could be confounded. Of late, as spreads tightened again, even some bond managers have been suggesting “there’s nothing left to buy”.
Warnings about a deterioration in credit quality also have a familiar ring to them: BBB-rated bonds now make up more than half of the US Agg index. The emergence of high-profile ‘fallen angels’ like Kraft-Heinz has reignited such talk at a time when yields are at record lows.
Issuance in both the investment-grade and high-yield markets has dried up amid the flight from risk this week. But in keeping with Treasury prices, the Agg index has continued to rise in the past few days, suggesting the diversification benefits of higher-quality bonds remain intact. That’s in contrast to the likes of specialised instruments such as ‘pandemic bonds’, which display uncorrelated qualities until the moment at which they become most relevant.
As we also noted yesterday, strategic bond funds remain DFMs’ preferred way of navigating out of this uncertainty. They tend to favour the high-yield debt that’s sold off sharply this week - but as it stands, most are still doing a capable job as diversifiers. Only the very riskiest have sustained (small) short-term losses.
Returns aren’t quite comparable from those derived from good old-fashioned gilt funds, but as a halfway house in a time of mass uncertainty, strat bond funds are still striking the right balance for now.
Remember the BATs? A little under 18 months ago, we examined global and emerging market strategies’ exposures to the tech names touted as the Asian equivalents of the FANGs - Baidu, Alibaba and Tencent. Since then, the direction of travel hasn’t been quite so obvious for this trio.
Our initial analysis marked a point of divergence for Baidu and Tencent in particular. The former was soon to see its share price slump, while the latter had just endured several months of the same.
As a result, both have fallen from favour with DFMs’ favourite emerging market funds. Of those we examined in November 2018, all but one of the Baidu holders has cut back their positions drastically - the stock no longer ranks as a favourite of any of the funds mentioned.
For Tencent, the story is slightly more nuanced. Plenty of positions have been trimmed, despite the stock’s recovery in recent months. But the internet group still has plenty of backers, and now ranks as a top position for RWC Emerging Markets. Other emerging market strategies - though not those most favoured by wealth managers - are also now rotating back into the company at the expense of South Africa’s Naspers, which owns a hefty stake in the Chinese firm. The Genesis Emerging Markets trust is one such investor.
That leaves Alibaba, which remains an uncomplicated buy for most emerging market strategies. Positions in the stock climbed higher over the course of 2019. They’re not alone, however - it remains one of the most popular holdings for hedge funds worldwide. For now, the BATs have lost their wings, and the A is flying solo.
Inside the cave
Another part of the investment industry that’s surging in size is hidden behind the scenes: BlackRock’s Aladdin technology. The FT’s Big Read from earlier this week examined how the risk management software has become an increasingly significant cog in the asset management machine.
There are now isolated examples of investors declining to use the system because of the potential for “groupthink” - the risk that, with so many investors relying on Aladdin to gauge risk, they all end up moving in the same direction come crunch time. But there’s little evidence this is a widespread belief among fund firms and other users.
Ultimately, given how closely aligned most investors are with one another at the moment anyway, a rush for the door will be tough to avoid when the moment comes. Wherever you look, the interconnectedness of the investment industry is hard to escape.