Q2 2020 will most likely be remembered as one of the worst quarters for global GDP growth since World War II. In a time of uncertainty, we believe investors are better off owning bonds than equities.
Why the financial sector
This is the most regulated market and has been stress tested by regulators, so we know the sector can absorb external shocks such as Covid-19. Covid-19 is an earnings story for sure, but not a balance sheet story.
Why sub-debt for financial sector
Investors benefit from the strong credit quality of these issuers, in addition to benefiting from a significantly higher income.
The power of pull-to-par
While income is steady, the price of a bond fluctuates; however, as long as the default risk does not increase, it typically converges toward par value. Therefore, if the price of the bond declines, but the default risk does not change, a unique opportunity to invest is created.
Extension risk as a buying opportunity
When callable perpetuals are priced to perpetuity because of weak market conditions, they tend to gradually reprice to the next call date as soon as the situation stabilises. This means there is the potential for high capital gains.
While the price of bonds has declined, regulatory framework has not changed, meaning free option in terms of capital gains has just increased, as issuers will need to take these bonds out.
Historic record of bounce back
We just experienced one of the biggest monthly drawdowns since 1985, with no change in the credit fundamentals. Each time this has happened in the past, the prices of our bonds recovered within six to nine months.