Discretionaries' credit quest hits on an old favourite; Quality fund picks and ESG issues
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Square peg
Investment markets have started sending out a familiar mixed message: equities are moving higher, but government bond yields are signalling economic concern.
This time, the debate over which indicator is “right” is a little simpler to process – insofar as almost every allocator recognises a serious economic contraction has begun. The rise in risk assets points to medium-term optimism, not a disbelief in the near-term outlook.
For wealth managers, one missing piece of the puzzle is how credit slots into this picture. In the past, riskier corporate debt joined in the equity and bond rally. The imminent recession means that’s a harder act to follow this time.
High-yield spreads have tightened materially since the mid-March blowout, not least thanks to central bank intervention. But the question of what’s next is dividing opinion among investors.
Our own sample of fund firm sentiment shows half are now outright positive on high yield, up from 30 per cent at the start of the year. Artemis’ James Foster is among those in the middle ground, saying he is likely to increase exposure, but only when the economy “returns to some normality”. And analysts at SocGen, not unreasonably, think high-yield indices both in Europe and the US will now underperform investment grade debt as the recession gets underway.
DFMs, as we’ve discussed, have been keen to participate in the credit rally. But they too are still expressing some caution on junk bonds. Some have opted for IG exposure instead. And many who have bought high-yield are returning to an old favourite.
Axa US Short Duration High Yield was removed from several portfolios last year, but is now back near the top of allocators’ go-to lists. The strategy’s drawdown was about as severe as any other junk bond offering's during March’s slump. But discretionaries are betting its short-duration focus will manage to serve them better – while simultaneously offering a decent yield - once the anticipated slowdown takes hold.
Two steps back
Quality equity funds are another area to which selectors returned last month. Estimates from Morningstar show both Fundsmith Equity and Lindsell Train UK Equity took in sizeable amounts in April having seen money depart amid the sell-off.
That’s unsurprising, given how the bull market trends of past years have reasserted themselves in recent weeks. And research from BFinance suggests the quality part of the market is a particularly happy hunting ground for active managers in general.
The firm says such managers “seem to beat quality indices with a high degree of consistency”, outperforming net of fees in seven of the past ten years.
That finding doesn’t just have consequences for Terry Smith, Nick Train and their kind. ESG managers, as BFinance notes, tend to have a particular bias towards the quality style. That's helped them outperform this year as well as in recent times. Fund flow figures suggest this has cemented their popularity, even as other parts of the market have seen outflows.
But there are also reasons for caution: research from Boston Consulting Group has found that investors’ interest in ESG has dropped back amid the pandemic.
Concerns of this kind have long been an area of emphasis for sustainable investing naysayers. That said, the BCG poll did find this drop had “stabilised” in recent weeks, suggesting attitudes are now ingrained in some form. The next test of that sentiment would be a downturn in which the quality investment style starts underperforming rather than maintaining its position as market leader.
The price is right
One other discussion now starting to resurface, albeit somewhat ahead of time, is whether the monetary and fiscal stimulus packages currently in train around the globe will lead to the return of inflation.
The spectre of surging price growth was in the back of many investors’ minds for much of the past decade, but deflationary pressures eventually won a decisive victory in that battle. This year, each round of extraordinary monetary stimulus increases the odds that debates over the ‘I’ word will ultimately return to the spotlight.
And some are marshalling their troops ahead of time: Goldman Sachs chief economist Jan Hatzius has “pre-emptively” noted that the firm “does not share these concerns” over inflation, given the amount of time it’s likely to take for economies to return to normal. Yet as with previous debates of this nature, opponents are unlikely to go down without a fight. We’ll examine DFMs’ own stance on the issue later this week.
