What’s your fixed income investing outlook?
We think it’s a pretty good environment for fixed income right now. We have seen a real shift from last year, and central banks – led by the Federal Reserve – appear to want to ease and reflate the global economy. Given this backdrop, we think it’s time to think about extending duration.
Looking ahead, we expect there will be more volatility – especially in credit markets. That’s great news for active managers; we are definitely looking to take advantage of the volatility in the marketplace. December 2018 was a great example of that, as we were able to add to our high yield exposure as spreads widened out and valuations became more attractive. So we see more volatility, but we don’t foresee an imminent recession – that presents a great environment for active managers.
We’ve also raised our cash allocation recently. That gives us a defensive buffer, but it also allows us to buy during selloffs, like we saw in December. Things are really starting to get fun again, at least from our perspective.
What’s your approach to fixed income investing? How does your multisector approach compare with core and core plus strategies?
The first thing to mention is that we are multisector by nature. That means we tend to be invested broadly across the market in assets such as high yield, investment grade, loans, emerging market debt, mortgage-backed securities and treasuries. They are really one-stop-shop portfolios that can go anywhere, depending on where we see opportunities. We are not constrained by benchmarks, so most of our portfolios are starting with quite a bit more risk, so they are going to look a bit different from a core or core plus fund.
In terms of our investment approach, we do a lot of bottom-up work and credit analysis. We use that bottom-up work to inform our top-down analysis, which allows us to go into detail about certain countries and sectors. Anyone can look at inflation expectations, GDP and PMI readings, but we want to use our research depth to dig deeper to understand what’s going on.
And, of course, we have top-down models and a lot of risk assessment tools that help us think about the best ways to position portfolios.
You have a lot of exposure to high yield, especially compared with loans. Why?
There are a couple of reasons. First, we don’t use a lot of bank loans because they don’t offer enough liquidity. We think liquidity is becoming more and more important in bond markets for a number of reasons, so we want to remain relatively flexible. We think high yield has sound fundamentals. The size of the high yield market is shrinking and issuance has stalled, but the coupon is still there and provides good carry over other assets. At the same time, the US is one of the strongest economies in the developed world, even if we have seen some slowing, and it’s one of the few high yield markets where you’re getting adequately rewarded for the risk you’re taking – with yields at more than 6% now. You’re just not going to get that in Europe, while emerging market corporate debt is very richly valued and not a good risk/reward trade at this time.
Leverage is creeping up, but it has not reached levels of 2015 or 2016, and interest coverage is strong. With the economy still humming along, we think companies in general are in decent shape. And finally, more esoteric assets such as bank loans, which have exploded in size, are much harder to manage. There is less liquidity, so you need to be investing with somebody who’s doing really deep bottom-up work and looking at the covenant packages, reading the prospectus and doing a huge amount of due diligence. It’s not worth the effort when they don’t currently offer the returns or liquidity.
What about emerging market debt? You mentioned that you think it’s expensive.
Emerging market (EM) debt does seem attractive long-term from a demographic and growth perspective. The problem is that the corporates are super rich. There has been nothing but buyers into the sector, so spreads have come down massively. We do own some EM corporates, but our exposure has decreased dramatically. We’re only really holding names where we see upgrade potential or where there’s a really strong story.
We continue to own non-dollar sovereign debt. We own Mexico, and Argentina could be getting interesting. The Philippine peso is another area we’re looking at. There are a few different areas that are getting interesting, and there’s an opportunity to get some upside from both currency and carry. We don’t rely just on the currency for returns.
Over the long term, I think emerging markets are in a pretty good place. I do worry, however, about the change in the developed world toward populism. Emerging markets have been the main beneficiaries of globalization, and now you have a turn toward protectionism, trade tariffs and de-globalization. That’s something we’re watching.
Are there any major risks or worries you see on the horizon? Are you concerned about a recession?
There are a lot of reasons and we think we’re late-cycle. We don’t think we’re dipping into the downturn, however, and so there’s still time to seek opportunities in some of those markets such as high yield.
I think the probability of a recession in the next 12 to 18 months has ticked up to about 10%, where we had zero before. The only main reason for that is an uptick in geopolitical uncertainties. But a near-term recession is still not even close to what we’re thinking as a base case.
One major concern we do have is China – both its debt and its slowdown indicate the country is obviously trying to enact more stimulus, but we have yet to see what effect that’s having. Is it going to be too little too late? Is it going to keep the engine running and the economy growing at 5% or 6%? And, if so, what does this mean for the future, since credit expansions and bubbles can’t go on forever?
At the same time, US/China tensions are not going anywhere. Even if the Democrats get into office and handle things differently, we think that there will still be a lot of tension there. We’ve become a multi-polar world. That’s not the most investment-friendly environment, but it’s more nuanced than just being risk-off or not investing at all. I think that’s another reason why it’s important to be flexible and to invest with an active manager – and a manager that can monitor these risks and shifts and take advantage of any volatility or change that occurs.
So you’re not looking at Chinese government bonds, despite their index inclusion and strong performance?
They have done well, and when something is new, I’ll admit that I want to be the buyer – the first-time buyer. A new asset class is my favorite place to go, and index inclusion may prove to be a powerful tailwind. But when it comes to China, it’s not a risk we want to take – especially on the currency side. Not when our biggest worry is China.
Mortgage-related and asset-backed securities are subject to the risks of the mortgages and assets underlying the securities. Other related risks include prepayment risk, which is the risk that the securities may be prepaid, potentially resulting in the reinvestment of the prepaid amounts into securities with lower yields.
Bottom-up investing is an investment approach that focuses on the analysis of individual stocks and de-emphasizes the significance of macroeconomic cycles and market cycles.Top-down investing is an investment analysis approach that involves looking first at the macro picture of the economy, and then looking at the smaller factors in finer detail.
Duration risk measures a bond's price sensitivity to interest rate changes. Bond funds and individual bonds with a longer duration (a measure of the expected life of a security) tend to be more sensitive to changes in interest rates, usually making them more volatile than securities with shorter durations.
Emerging markets refers to financial markets of developing countries that are usually small and have short operating histories. Emerging market securities may be subject to greater political, economic, environmental, credit and information risks than U.S. or other developed market securities.
High yield bonds are rated below BBB/Baa. Ratings are determined by third-party rating agencies such as Standard & Poor's or Moody's and are an indication of a bond's credit quality.
Liquidity risk exists when particular investments are difficult to purchase or sell, possibly preventing the sale of these illiquid securities at an advantageous price or time. A lack of liquidity also may cause the value of investments to decline.
Natixis Distribution, L.P. is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers. Natixis Distribution, L.P. (fund distributor, member FINRA | SIPC) and Loomis, Sayles & Company, L.P. are affiliated.