Asset prices have rallied sharply off their lows in recent days as a result of the massive economic support packages that have been put in place by governments and central banks around the world. The pace of formulation and enactment of these measures, alongside their scale, simply help to underline the vulnerability of a global economy to the shutdowns being announced across the globe.
The threats to the global economy are now well understood and much has been priced into asset markets, however President Trump’s suggestion that the US will be able to get back to work after Easter (12th April) seems wide of the mark. Evidence that more countries will need to extend their lock downs in a manner similar to that of Italy may knock confidence. That said, hard lockdowns have the potential to contain the virus, and if and when this is evidenced, some return of confidence is likely as investors anticipate economic recovery. Timing the re-entry will be difficult particularly as there is the wild card of the depressed oil price which can be resolved at any time if key suppliers agree to limit production.
As a result, we have been looking to add risk where we see asymmetric return profiles. The two most obvious places to focus on are credit and convertible bonds. Areas within the high yield and loans markets are now pricing in significant default risk. Even with a default cycle, a portfolio of such assets may well generate decent medium term returns given current yields and policymaker support. We have therefore increased exposure to a strategic bond fund which has navigated the recent market storms successfully, and is now looking to add credit exposure selectively.
Global convertible bond funds are also interesting. Share prices have fallen significantly meaning that some of these funds are trading close to their bond floors (which have also moved down due to a stressed credit environment). The fund which we have added exposure to (for our more risk tolerant mandates) is now generating a healthy (contractual) yield and will act more like a credit fund until equity markets rally, when it will then participate meaningfully in the equity upside. Given recent Sterling weakness, we have added to the fund’s Sterling hedged share class to protect against the risk of Sterling strength.
Cornelian Investment Team
27 March 2020
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