Corporate spreads have come down from their highs in late March, but the bounce back has not been uniform across asset classes. For example, emerging markets have generally lagged high yield, due to their high reliance on oil exports and tourism.
We have always favoured diversification, as that is one of the best ways to help protect investors from unexpected shocks and add resilience to portfolios.
At the beginning of this year, optimism seemed to fuel markets, taking valuations to levels that we felt, in many cases, did not allow any room for disappointment. We obviously did not anticipate the coronavirus pandemic, but the extreme optimism prevalent beforehand made us cautious.
It is in these times that a strong framework for assessing risk and return is especially critical.
One way of doing this is to rely on the concept of concentric circles: that is, to place the most liquid, least-risky asset classes at the centre, and populate outer rings with increasingly less liquid and riskier segments.
Investors should earn increasing risk premium – and potentially higher return over time – as they move out from the centre.
The historic market sell-off in March affected every circle, even the safest asset classes near the centre, but created possible opportunities across them as well.
The volatility cheapened valuations across quality and sectors, lowering the entry point for a broad range of securities.
While this presented potential opportunities for investors, it is important to understand that lower prices do not always mean attractive valuations.
In the case of residential mortgage-backed securities, however, we have benefited from the March volatility, as well as from positive fundamentals (high levels of asset coverage) and strong fiscal and monetary support – especially from the US Federal Reserve.
We remain confident onUS housing market fundamentals, which were already strong overall going into this crisis. Seasoned mortgage-backed security issues also remain resilient as borrowers have built considerable equity in their homes.
Within corporate credit we have been favouring investment grade issuers, which historically have experienced low default rates and can perform well in a broad variety of possible scenarios.
Specifically, financials are one of the areas where we saw opportunity, given the significant volatility many banks suffered in March, despite their strong fundamentals.