Is investing in US bonds a moral hazard?

This was a question posed recently by managers at Evelyn Partners, who spoke at an event of the difficulty managers face when balancing a need for income and inflation protection with the need to follow environmental, social and governance matrices. 

For example, one of the managers asked, would investing in short-dated T-Bills or high-quality US corporates be considered a wise move for long-term portfolio diversification or a breach of ESG ethics?

The manager asked: "What of the reversal of Roe vs Wade? What of the fact the US keeps dipping in and out of the Paris Agreement?

"What might investors feel about the fact there is the death penalty in 24 states or the fact that the right to bear arms is enshrined in the Constitution?"

The old adage has held: don’t bet against America, either financially or ethically.Richard de Lisle, VT De Lisle America fund

FTAdviser approached US and fixed income managers to ask whether investing in the US could pose moral hazard.

Richard de Lisle, manager of the VT De Lisle America fund, said: "If investing in America confers moral hazard, then it’s not just T-Bills this conjecture applies to.

"The asset of choice this bear market is the dollar. In the 1970s, the nearest period by analogy, was gold.

"However, in the 1970s Nixon had shot the dollar in both feet by coming off the gold standard in 1971, so the dollar wasn’t trusted as an inflation hedge even though the US was a relatively sound and lower inflation constituency.

"Today there is nothing more trusted: the US has the strongest economy, is ahead in the interest rate cycle and is protected from supply shenanigans by being a petro-currency.

"Thus, the dollar is the ultimate risk-off bet, typically expressed through T-Bills."

But he said if the proposition that investing in T-Bills would equate in some investors' view to a breach of their ethical values, he said there were more questions an investor should ask.

De Lisle explained: "If this proposition is a quandary, how do the ethical investors feel about the dollar itself, or the US equity market which is fully 60 per cent of the world cap?"

Moral relativism

Therefore investing in a passive fund, or in any fund with exposure to the US, could expose investors to 'moral hazard' if they feel the US is indeed a market they would prefer to avoid on ESG principles.

But, de Lisle said: "Instead, let’s consider US moral relativism.

"No polarisation of US voters makes the US truly populist due to the checks and balances of democracy.

"Here’s an example: the Trump appointee Clarence Thomas revokes Roe v Wade and ushers in the best hope for the Democrats in the mid-terms.

"Could this traditionalist judge unite liberals and achieve the opposite of his life’s goal? Then see Trump himself as Gulliver, tied down by thousands of lawsuits as the Lilliputian efforts of democracy ebb his ebullience.

"For as long as we remember, the old adage has held: don’t bet against America, either financially or ethically. Don’t give up."

Furthermore, Maria Staeheli, senior portfolio manager at Fisch Asset Management in Zurich, believes fixed income, particularly in the US, can provide a "compelling alternative to equities" in these current markets. 

She said: "With its decisive action, the Fed has achieved first successes and, for the time being, has also managed to maintain its credibility.

"While it could push the US economy into recession, any recession, however, is likely to be less severe than in Europe.

"We therefore see additional potential for equity market losses due to a possible combination of negative factors, which could act as a double whammy.

Fundamentals of US IG corporates are very solid.Maria Staeheli, Fisch Asset Management

"First, earnings expectations, which are currently still quite robust, could see further downward revisions or the market could be surprised by disappointing corporate results.

"Second, given negative market sentiment and rising risk premiums, earnings-based multiples may also decrease. Conversely, for high-quality bonds, where risk premiums are less sensitive to corporate results, the worst is likely over in our view."

She said defensive investment grade corporate bonds were currently compensating for the risk far better than equities.

Staeheli added: "This becomes evident, for example, when comparing yields."

The yield on US IG corporates currently stands at 5.5 per cent, equal to the S&P 500 earnings yield, which includes dividends as well as retained earnings and puts them in relation to the share price.

See Trump himself as Gulliver, tied down by thousands of lawsuits as the Lilliputian efforts of democracy ebb his ebullience.de Lisle

She said: "This situation of these very different asset classes providing the same yields was last seen at the height of the financial crisis, when corporate earnings fell sharply on the back of the recession.

"In our view, this opens up a particularly attractive opportunity as investors can choose a more defensive investment without sacrificing much yield.

"IG credit also looks favourable relative to high yield as heavy new issuance has caused IG spreads to widen significantly more than the typical relationship to high yield would imply.

"Fundamentals of US IG corporates are very solid, and they appear well equipped to deal with the expected macroeconomic headwinds."

simoney.kyriakou@ft.com