6 minute read
Global Fixed Income: Opportunities Amidst
BY FRANCK DIXMIER, CHIEF INVESTMENT OFFICER FIXED INCOME AT ALLIANZ GLOBAL INVESTORS, AND MATTHEW CHALDECOTT, PRODUCT SPECIALIST GLOBAL FIXED INCOME AT ALLIANZ GLOBAL INVESTORS
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It is hard to overstate the speed of disruption in economic activity and financial markets in 2020, due to the pandemic and the fall in oil prices. The full measure of the decline in economic activity may not be known for some time, but indicators from across the world suggest bigger contractions than witnessed even during the 2008/09 Global Financial Crisis. Predicting the form of any recovery is challenging to say the least, but our base case is for only a shallow recovery.
In the financial markets, the threats of demand destruction and deflation set off a chain reaction: with corporate revenues and asset prices declining, while future liabilities remained fixed or increased in real terms, equity values quickly shrank with falls of around 2530% in major stock markets.
With equity cushions eroded and enterprise valuations diminished, the contagion into credit was next as the threat of downgrades and default became elevated. This is clearly a function of company creditworthiness and proximity to the shocks, so credit spreads reacted accordingly, with lowerrated companies, energy and leisure/ travelrelated names suffering the most.
Photos: Archive Allianz Global Investors The rating agencies, not wishing to repeat the mistakes of the Global Financial Crisis, have acted swiftly and assertively to downgrade companies.
While they have been justified in most cases, these actions have exacerbated the situation as many institutional investors or mutual funds are restricted in holding subinvestment grade names.
Finally, many mutual funds and institutional portfolios faced substantial redemptions and collateral calls, such that they were forced to sell holdings on short notice and with few takers on the other side. In many cases, only the highest quality and most liquid securities could achieve a sale with lower quality names left unbid.
This all sums up to one of the most significant dislocations in the market, surpassing in many respects that witnessed in the Global Financial Crisis. The uncertain outlook for the pandemic and its effects on the economy, combined with forced liquidations, have completely divorced security prices from their fundamentals.
How to respond
Investing must always be a forwardlooking exercise however, so we must think past the pandemic and into the recovery phase. Central banks have announced measures to combat the deflation threat, which is many times larger than that during the Great Financial Crisis; likewise, governments are enacting fiscal stimulus on a scale not seen since World War II.
Companies (and countries) will be seeking to repair their balance sheets; at first this will be negative for equities as cash is preserved and dividends or share buybacks are deferred. But these activities are credit positive, so returns within corporate bonds can be strong.
Here we see many opportunities amidst the confusion, which can be captured most effectively by the following three principles:
1. Be active; 2. Go global; 3. Be flexible.
On the first point, the separation of prices from value has seldom been greater and there must be reconciliation at some point. Particularly in fixed income, active managers have an opportunity to capture oversold but fundamentally solid corporates or issuers and earn a premium as realignment occurs, while passive funds are weighted according to the amount of debt outstanding. We know from the past (which of course may not be predictive of the future) that different sectors have varying degrees of leverage to the economic cycle – some will outperform in a downturn, while others will benefit more greatly in the recovery phase; indeed the two may be inversely correlated.
On the second point, different regions are set to recover at varying rates, while market performance has been indiscriminate, with higher quality and liquidity frequently acting as a negative influence. At the same time, the response from central banks globally has substantially diminished currency hedging costs, so that there is still an attractive yield for EUR investors after FX risk is taken out.
On the third point, if active managers are best positioned to exploit dislocations, then a wider opportunity set and discretion should be beneficial. In a typical bond mandate, this could apply to offbenchmark assets such as subinvestment grade issuers, emerging market countries, or floating rate notes, which have seen spreads widen proportionally more than their fixed rate counterparts, even for the same issuer.
We believe that one area of opportunity exists within the ’fallen angel’ space. Historically, issuers falling out of investment grade have outperformed both the wider high yield index and the high grade universe. This is due to a combination of the demand dynamics as many institutional portfolios may
Figure 1: Returns Fallen Angels index versus Global Broad Market Corporate index and Global High Yield index
Source: Bloomberg. Returns in USD unhedged terms.
not hold the issues, creating a market inefficiency, and also the supply as companies want to restore themselves to their former position. The price action tends to be frontloaded, such that falls occur in anticipation of a downgrade rather than on the event itself.
Allianz Global Investors can help
Our Global Fixed Income team has a strong track record investing in both sovereign and corporate bond markets reaching back over 35 and 20 years, respectively. They have always adhered to the aforementioned three principles, while carefully assessing each opportunity on a fundamental basis.
Conclusion
Amidst all the panic and confusion, now is the best time in the last decade to consider active reallocations and act to take advantage of the market dislocations. The uncertainties of the health crisis could last for some time, but we think there is now sufficient value back in Fixed Income markets to warrant taking the risk and we don’t want our clients to miss this opportunity. « • Financial markets have been
comprehensively dislocated as a result of the Covid-19 pandemic and oil price collapse;
• Forced selling and limited
transparency on the outlook have created opportunities for those brave enough to take them;
• Active management should be
best placed to benefit, with the maximum potential from a flexible and global approach;
• Allianz Global Investors has
market leading capabilities in
Global Fixed Income; our franchise has been successfully investing in both sovereign and credit markets through many different cycles.
Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Past performance is not a reliable indicator of future results. This is a marketing communication issued by Allianz Global Investors GmbH, www. allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 4244, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). Allianz Global Investors GmbH has established branches in the United Kingdom, France, Italy, Spain, Luxembourg and the Netherlands. Contact details and information on the local regulation are available here (www.allianzgi. com/ Info). 1157046 | 201399
