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Recalibrating the rulebook: 360°, Q2 2020

What is our current view of fixed-income markets? And where do we see the best relative value? In our latest edition of 360°, Andrew ‘Jacko’ Jackson, Head of Fixed Income, and his team of specialist investors considers the areas that have the potential to deliver superior risk-adjusted returns.

Navigating the new normal

In previous editions of 360°, we had warned about the level of complacency in markets. Buoyed by central-bank support, the market seemed to be pricing in a near-perfect world with almost no tail risk. Since then, the coronavirus pandemic has had a colossal impact on markets that is correlated across geographies, sectors and asset classes – credit included.  

Yet even in the eye of the storm, we remain optimistic about the opportunity to seek out idiosyncratic stories in credit markets over the next 12 months. Remaining mindful that the lows are likely not behind us, an active, high-conviction approach should help us recalibrate our models and ascertain which credits have the capacity to weather any further volatility.  

In this issue of 360°, we carry out our usual survey of fixed-income asset classes and also take a closer look at fundamentals within the energy sector and financials, changes to lending in response to the current crisis and recent developments in the world of environmental, social and governance (ESG) investing.

See below for a flavour of these sections or read the full report for a more comprehensive picture.

To help formulate our view of broader market fundamentals, we look at the two sectors we believe have been most affected by the crisis: financials and energy.

The energy sector has been hit by oil-price war between Saudi Arabia and Russia and the virus-induced decline in demand. The market is faced with material oversupply and the oil price has plunged: bankruptcies have already started and there will be material implications for credit markets.

Banks have also been affected, as corporates have drawn on their revolving credit facilities at an unprecedented pace. Nonetheless, the capital position and balance-sheet strength of banks is stronger than in 2008, something that does not seem to have been priced in. Moreover, banks – particularly ‘national champions’ – will be used as the transmission mechanism for stimulus, meaning they are unlikely to be allowed to fail.

Governments have proposed a range of initiatives to protect businesses and citizens from the coronavirus pandemic. Because these measures will provide support when defaults inevitably spike, they are likely to bolster credit markets.

Banks and lenders are under considerable pressure to behave responsibly towards borrowers: interest holidays are in place, while companies have also received support through loan-guarantee schemes and liquidity facilities.

Initiatives have also fed through to structured-credit markets. Most European securitisation is backed by loans to consumers, which will be under pressure as the decline in economic activity has depressed personal incomes. Various measures have been adopted to help consumers meet their debt obligations, including payment holidays for mortgages and credit cards.

Before the sell-off, we were often asked if the growing prominence of ESG investing was due to the fact that we were in a record-long bull market. The implication was that ESG is a luxury that can be enjoyed so long as we can afford it.

A closer look at capital-market activity in the early week of the drawdown suggests that this is not the case: a considerable number of firms issued green-debt instruments over this period, while the volume of ESG bonds released in Q1 declined only modestly on the year before.

We also take a look at our stewardship team’s engagement activities during the drawdown. Because the sell-off has acted as a test of underlying corporate cultures of responsibility, we believe it offers a unique opportunity to understand how companies stay true to their values during times of crisis.

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