Taking the `high’ out of high yield
The fixed income team has held the view for some time that corporate credit is getting expensive, said Harry Richards, Fund Manager, Fixed Income. High-yield bonds no longer generate high yields; in fact, the yield on US non-investment grade is at an all-time low, he said.
Oxymorons aside, this means investors must accept lower compensation for the credit risk they take on. US investment grade corporate credit spreads, or the difference in yield versus government bonds, is the tightest on record, with high yield spreads not far from a record low.
These valuations reflect one-sided positioning in the market, in Harry’s view. The consensus trade is around reflation of the economy after the pandemic, backed by massive central bank support. The market overwhelmingly expects dollar weakness, strength in commodities, weakness in long-dated bonds and less volatility, he said.
While this view is valid, Harry commented that when everyone sits on the same side of the boat, even a small cross-current can capsize the boat. The team’s view is that it does not make sense to be all-in on the consensus trade, so they have been cutting exposure to investment grade credit and rotating into other opportunities, while still maintaining a significant exposure to high quality sovereign bonds to protect against potential tail risks, he said.
Lastly, the team have exited the Russian sovereign bond market due to governance concerns about the arrest and imprisonment of government critic Alexander Navalny. The recent protests have been broad-based, and Harry said the team see a risk of Europe and the US increasing sanctions. As such, they think it is better to be on the side-lines in Russia now.
Year of the Ox could pay dividends, but watch for inflation
The Year of the Rat is behind us and we’re now into the Year of the Ox, said Jason Pidcock, Head of Strategy, Asian Income, and there is a lot of positive news flow coming out of Asia, both from an economic and a corporate profitability point of view. Importantly for Jason and other equity income investors, there are also positive indications about dividend payments for the coming year. In particular the technology, financial and commodities sectors have seen quite a few earnings forecast upgrades.
In Jason’s view there is greater inflation pressure to come, with the valve released as lockdowns ease across the world, so he’s thinking long and hard about the pricing power of companies in the Asia Pacific region. Even companies that are able to raise their own prices will have to cope with increased input costs, so that’s something to factor in too. Jason was recently in a meeting with the CEO of a gold mining company – profits are up and the company has raised its dividend five years in a row, but one potential risk is a higher iron ore price driving up the price of the steel they need, as well as raising competition for labour which would see wage inflation.
Generally, the dividend news has been strong year to date. Jason had been expecting dividends to be down year-on-year, given the comparison with Q1 2020 which saw the distribution of pre-pandemic earnings. He’s been pleasantly surprised, though, with how many companies have beaten consensus expectations on dividends. That bodes well for the second half of the year in particular, and he anticipates that, for many of the attractive income stocks he looks at 2021, will see higher payouts than 2020.
Repair, maintenance and improvement for UK equities in 2021
A relatively orderly Brexit, and the UK’s success (at least compared to Europe) in its vaccine rollout, have helped strengthen sterling somewhat and provided a boost to UK domestic stocks, said Luke Kerr, Fund Manager, UK Small & Mid Cap.
The different strains of Covid-19 emerging around the world has given a further knock to travel-related sectors, however Luke and the team see relatively more attractive opportunities in pure domestics. This includes sectors related to home repair, maintenance and improvement, which Luke says should see a longer runway of growth over perhaps 3-5 years as people adapt their living environments to the reality of more home working. By contrast, some of the hospitality plays, such as pubs, are already pricing in a recovery this year as lockdown restrictions ease, so represent less compelling value than they otherwise would have done.
Finally, Luke spoke about a renewed surge of IPOs, after a few years when there was very little of quality. Some of the companies listing recently have admittedly come to market on fairly full valuations, but they do nevertheless include names that Luke and the team see as attractive on a medium-term view. Price discipline is important when assessing these opportunities, but it’s a welcome development that new blood is coming to the listed UK mid and small cap equity universe.
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