’60/40 is being resuscitated’: fixed income down but not out
Year-to-date, fixed income markets are about as bad as equities. But Michael Leithead, fixed income and senior portfolio manager at EFG Asset Management (EFGAM), is more positive than he’s been “in a long time.”
“We’re at a point now where the market has priced in quite a lot of global policy tightening, and that restores some of the negative correlation you’ve got with risk assets,” Leithead says. “If we start to see a slowdown in demand, if we start to see the risk of recession, it’s going to be positive for safer assets… 60/40 is being resuscitated.”
With the resumption of international travel, Leithead has joined the scores of other international asset managers journeying Down Under for a foundational audience with the super funds. EFGAM – the asset management arm of Swiss private bank EFG – already has a toehold in the local market through its parent’s ownership stockbroker Shaw and Partners, acquired piecemeal since 2019.
EFGAM is now stashing money in investment grade developed market debt – longer duration assets in BBB+ and A names are looking “relatively attractive” – while what’s priced into US dollar and euro markets is “pretty aggressive” relative to their historical rate hiking cycles. ESG is a “nascent part” of fixed income, but sustainability is going to be a big theme, particularly for high-yield companies that will suffer significant impacts from potential carbon pricing regulation that would give them a new debt while they’re only just covering their interest.
In its Wealthy Nations Bond Fund, it’s looking to the “ideal borrower” – “overlooked” high quality emerging markets that are net savers. Turkey’s debt-to-GDP ratio is quite low – a mere 42 per cent – but the rest of the economy is borrowing heavily from abroad, and suffers from perpetual ratings downgrades. At the other end of the spectrum is Japan, one of the most indebted countries in the world, with a debt-to-GDP ratio of 259 per cent. But its private and household sectors have huge amounts of savings, and are net creditors to the rest of the world.
“It’s based on a concept of inefficiency in fixed income markets. Benchmarks are constructed from the most indebted companies in the most indebted countries,” Leithead says. “Does that really make sense when you’re lending them money? We don’t think it makes sense to lend your money to the people with the greatest amount of debt outstanding because they face the greatest refinancing risks. They’re much more reliant on markets.”
It’s a strategy that’s carried a lower yield relative to emerging market debt, but one that hasn’t been exposed to some of the riskier countries – except Russia, which looked like it had a “pretty resilient economy” prior to its objectively mad invasion of Ukraine, and to which the Wealthy Nations Bond Fund’s exposure was around five per cent.
“People were generally surprised by the fact that they invaded and the scale of that invasion. Most people saw what Putin didn’t see – that it was going to be a disaster. If you think about every conflict in the recent past – being involved in conflict where you’re fighting in cities and coming up against a determined domestic foe, you’re going to meet heavy resistance.”
But the macro outlook isn’t as bad as it seems. A recession is by no means set in stone. Leithead isn’t as gloomy on inflation as some of his peers, and believes the current paradigm will ultimately prove more transitory than it seems. A lot of the inflation is supply-side orientated; to get really sticky high inflation, you need a wage price spiral, and he’s “far from convinced” of that possibility. There could be short-term wage negotiations – as we’re now seeing around the world – but it’s a question of whether they become embedded in people’s expectations.
“Will we see a reversion of some of those people who have been aggressively hiring? There’s anecdotal evidence of US companies who have over-hired during Covid,” Leithead said. “I’m not entirely convinced that what we’ve got isn’t a transitional stage of policy around Covid, where people have been furloughed or given handouts or they’ve decided they want to change jobs.”
“I think companies will look at things like productivity and things like automation… I think people will still be worried about their jobs, and if we have an economic downturn, would you rather lose your job or get a three per cent pay rise instead of a five per cent pay rise?”