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MITON’S DAVID JANE: ARE FIXED INCOME INVESTORS TOO FIXATED ON BENCHMARKS?

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MITON’S DAVID JANE: ARE FIXED INCOME INVESTORS TOO FIXATED ON BENCHMARKS?
  • Fixed income benchmarks come with significant risk of negative returns
  • Prevalence of very poor quality credits coming to the markets
  • Investors need to be a genuinely active at times of heightened risk 

David Jane, manager of Miton’s multi-asset fund range, comments:

“It’s a simple but depressing fact that the vast majority of investors, or at least investment managers, are to some extent trying to beat an index. This isn’t necessarily a problem, until there’s too much money chasing too few good investments.

“This can be compounded in fixed income because the biggest components of the indices are those companies with the most debt. So supply creates its own demand. The same goes for equity, to a lesser degree, as the most expensive companies tend to have higher weights in the index.

“In favour of the index-plus approach is the argument that by selecting specialists for each asset class, and then charging them with beating that asset class, investors will get a superior return. This is a reasonable case, however, it of course ignores the most important decision of all – should you invest in the asset class in the first place?

“The index-plus investor never need make that decision, they must simply plough on investing the money as their clients have asked them to, into the asset class, irrespective of whether they think it offers the prospect of an attractive return.

“We raise this issue in the context of a very active fixed income issuance season. Very few investors in fixed income look upon the asset class as we do, i.e. from the context of being long only, unleveraged, and multi asset. Of those that do, few are outcome driven rather than benchmarked.

“For most investors, if they are worried about rising bond yields, they will have less duration than their benchmark. If they are worried about credit, they will carry less credit risk than their peers. This seems sensible until we consider what has happened to the benchmark, which has been consistently rising duration. So, a bond investor who runs a duration one year shorter than the benchmark duration today is taking more absolute duration risk than a neutral position only five years ago.

“The same goes for credit risk, although data is a little harder to come by as credit ratings are generally backward looking. New issuance defined as covenant light is now predominant in high yield, and the prevalence of very poor quality credits coming to the markets seems to move the risk all to the downside.

“When considering fixed income, we don’t consider any benchmark to be a proxy for our clients’ requirements and start from what might be termed first principles: what is the risk/reward of each investment we make and how does it fit within our overall portfolio.

“When looking at government bonds, conventional wisdom would say that long dated government bonds act as a good diversifier of equity risk in a mixed asset portfolio, as while they offer a lower total return they tend to rise when equities fall and vice versa. This would be a beautiful solution to the problem of running mixed asset portfolios, if only it were true.

“In fact, the correlation between gilts and equities is rather variable and while most often negative, not always so. Considering where we are today, one of the more probable causes of a setback for the economy, and hence equity markets, would be rapid rises in bond yields, then clearly gilts are not going to be a good diversifier. This, combined with the fact they are not offering an attractive income return, means they must be ruled out as the bedrock of a fixed income strategy. So we need to look elsewhere for diversification and return.

“A mainstream corporate bond strategy offers some of the same problems as gilts, yields are too low to offer an attractive risk/reward, particularly with credit spreads as low as they are, while interest rate risk is too high as the duration is too long. While the asset class offers slightly higher returns than gilts, overall downside appears to trump the upside.

“We need to look much deeper into the asset class to find the pockets of value which can offer a decent risk return profile. While the index for corporate bonds would suffer greatly from anything but the status quo, either growth is better, and hence yields rise, or growth deteriorates and spreads rise, leading to negative returns. Unless everything stays as is, we can find areas where the risk reward is more attractive, although to do so we must forego some potential upside.

“When we consider very short dated corporate bonds, particularly those issued many years ago when rates were higher we can find an attractive risk/reward profile. This type of bond can offer a decent yield pick up over cash while its total return is fairly independent of interest rates as its maturity is close at hand.

“While we must accept some credit risk, companies do not often fail completely without warning, so by avoiding industries and companies that are problematic, we can minimise, but not totally eliminate, this risk.

“So, our base case is dull, but steady returns, our downside is a smattering of defaults, reducing but not eliminating our return. But what of the upside? While not spectacular, there’s some upside from refinancing, as companies have a huge incentive to refinance higher coupon debt in order to reduce the interest cost to their profits and to do so they must pay holders a premium. So while we see little upside in buying the newly issued bonds we can see a little upside from owning those which get refinanced.

“In conclusion, we expect dull returns from fixed income, with the benchmarks offering a significant risk of negative returns either as monetary policy returns to normal as the economy grows and/or inflation rises, or from a weakening economy and hence credit spreads rising. This is a very poor risk reward profile, and a significant problem for benchmark hugging investors. It doesn’t however mean we must avoid the asset class altogether as we can find places where risk is much lower that offers a high probability of a positive, if low, return. At times of heightened risk you need to be genuinely active.”

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Not company earnings, not data but vaccines now steering investor sentiment

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Not company earnings, not data but vaccines now steering investor sentiment 1

By Marc Jones and Dhara Ranasinghe

LONDON (Reuters) – Forget economic data releases and corporate trading statements — vaccine rollout progress is what fund managers and analysts are watching to gauge which markets may recover quickest from the COVID-19 devastation and to guide their investment decisions.

Consensus is for world economic growth to rebound this year above 5%, while Refinitiv I/B/E/S forecasts that 2021 earnings will expand 38% and 21% in Europe and the United States respectively.

Yet those projections and investment themes hinge almost entirely on how quickly inoculation campaigns progress; new COVID-19 strains and fresh lockdown extensions make official data releases and company profit-loss statements hopelessly out of date for anyone who uses them to guide investment decisions.

“The vaccine race remains the major wild card here. It will shape the outlook and perceptions of global growth leadership in 2021,” said Mark McCormick, head of currency strategy at TD Securities.

“While vaccines could reinforce a more synchronized recovery in the second half (2021), the early numbers reinforce the shifting fundamental between the United States, euro zone and others.”

The question is which country will be first to vaccinate 60%-70% of its population — the threshold generally seen as conferring herd immunity, where factories, bars and hotels can safely reopen. Delays could necessitate more stimulus from governments and central banks.

Patchy vaccine progress has forced some to push back initial estimates of when herd immunity could be reached. Deutsche Bank says late autumn is now more realistic than summer, though it expects the northern hemisphere spring to be a turning point, with 20%-25% of people vaccinated and restrictions slowly being lifted.

But race winners are already becoming evident, above all Israel, where a speedy immunisation campaign has brought a torrent of investment into its markets and pushed the shekel to quarter-century highs.

(Graphic: Vaccinations per 100 people by country, https://fingfx.thomsonreuters.com/gfx/mkt/azgvolalapd/Pasted%20image%201611247476583.png)

SHOT IN THE ARM

Others such as South Africa and Brazil, slower to get off the ground, have been punished by markets.

Britain’s pound meanwhile is at eight-month highs versus the euro which analysts attribute partly to better vaccination prospects; about 5 million people have had their first shot with numbers doubling in the past week.

Shamik Dhar, chief economist at BNY Mellon Investment Management expects double-digit GDP bouncebacks in Britain and the United States but noted sluggish euro zone progress.

“It is harder in the euro zone, the outlook is a bit more cloudy there as it looks like it will take longer to get herd immunity (due to slower vaccine programmes),” he added.

The euro bloc currently lags the likes of Britain and Israel in terms of per capita coverage, leading Germany to extend a hard lockdown until Feb. 14, while France and Netherlands are moving to impose night-time curfews.

Jack Allen-Reynolds, senior European economist at Capital Economics, said the slow vaccine progress and lockdowns had led him to revise down his euro zone 2021 GDP forecasts by a whole percentage point to 4%.

“We assume GDP gets back to pre-pandemic levels around 2022…the general story is that we think the euro zone will recover more slowly than US and UK.”

The United States, which started vaccinating its population last month, is also ahead of most other major economies with its vaccination rollout running at a rate of about 5 per 100.

Deutsche said at current rates 70 million Americans would have been immunised around April, the threshold for protecting the most vulnerable.

Some such as Eric Baurmeister, head of emerging markets fixed income at Morgan Stanley Investment Management, highlight risks to the vaccine trade, noting that markets appear to have more or less priced normality being restored, leaving room for disappointment.

Broadly though the view is that eventually consumers will channel pent-up savings into travel, shopping and entertainment, against a backdrop of abundant stimulus. In the meantime, investors are just trying to capture market moves when lockdowns are eased, said Hans Peterson global head of asset allocation at SEB Investment Management.

“All (market) moves depend now on the lower pace of infections,” Peterson said. “If that reverts, we have to go back to investing in the FAANGS (U.S. tech stocks) for good or for bad.”

(GRAPHIC: Renewed surge in COVID-19 across Europe – https://fingfx.thomsonreuters.com/gfx/mkt/xegvbejqwpq/COVID2101.PNG)

(Reporting by Dhara Ranasinghe and Marc Jones; Additional reporting by Karin Strohecker; Writing by Sujata Rao; Editing by Hugh Lawson)

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BlackRock to add bitcoin as eligible investment to two funds

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BlackRock to add bitcoin as eligible investment to two funds 2

By David Randall

(Reuters) – BlackRock Inc, the world’s largest asset manager, is adding bitcoin futures as an eligible investment to two funds, a company filing showed.

The company said it could use bitcoin derivatives for its funds BlackRock Strategic Income Opportunities and BlackRock Global Allocation Fund Inc.

The funds will invest only in cash-settled bitcoin futures traded on commodity exchanges registered with the Commodity Futures Trading Commission, the company said in a filing to the Securities and Exchange Commission on Wednesday.

A BlackRock representative declined to comment beyond the filings when contacted by Reuters.

Earlier this month, Bitcoin, the world’s most popular cryptocurrency, hit a record high of $40,000, rallying more than 900% from a low in March and having only just breached $20,000 in mid-December.

Bitcoin tumbled 10.6% in midday U.S. trading Thursday.

Other U.S.-based asset managers will likely follow BlackRock’s lead and add exposure to bitcoin in some form to their go-anywhere or macro strategies as the cryptocurrency market becomes more liquid and developed, said Todd Rosenbluth, director of mutual fund research at CFRA.

“It’s easy to see how strong the performance has been of late and look at a historical asset allocation strategy that would have included a slice of crypto and how returns would have been enhanced as a result,” he said. “Large institutional investors are going to be able to tap into the futures market in a way that a retail investor could not do.”

There is currently no U.S.-based exchange-traded fund that owns bitcoin, limiting the ability of most fund managers to own the cryptocurrency in their portfolios.

BlackRock Chief Executive Officer Larry Fink had said at the Council of Foreign Relations in December that bitcoin is seeing giant moves every day and could possibly evolve into a global market. (https://bit.ly/2XXFHrB)

(Reporting by David Randall; Additional reporting by Radhika Anilkumar and Bhargav Acharya in Bengaluru; Editing by Arun Koyyur and Lisa Shumaker)

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Bitcoin slumps 10% as pullback from record continues

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Bitcoin slumps 10% as pullback from record continues 3

LONDON (Reuters) – Bitcoin slumped 10% on Thursday to a 10-day low of $31,977 as the world’s most popular cryptocurrency continued to retreat from the $42,000 record high hit on Jan. 8.

The pullback came amid growing concerns that bitcoin is one of a number of financial bubbles threatening the overall stability of global markets.

Fears that U.S. President Joe Biden’s administration could attempt to regulate cryptocurrencies have also weighed, traders said.

(Reporting by Julien Ponthus; editing by Tom Wilson)

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