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Weekly Manager Views

13 December 2019

At GAM Investments’ Weekly Investment Meeting held on 11 December, the speakers were Charles Hepworth, who examined cost efficient asset allocations, and Anthony Smouha, who discussed the search for yield.

Asset allocation

Charles Hepworth

  • Ever since the global financial crisis (GFC), the broad direction of financial markets – and asset class returns – has been dominated by central bank largesse in the form of monetary policy stimulus. As we head towards 2020, this largesse having been wound back since early 2018 by close to USD 1 trillion is again starting to increase again. But this situation cannot last forever and many economies are hoping for a greater focus on fiscal stimulus from their respective governments to continue the expansion going forward.

  • The upshot for financial markets is that we are transitioning out of an environment in which quantitative easing (QE) drives asset prices broadly up across the board. This raises the bar for successful investing in 2020 and increases the risks around asset allocation frameworks.

  • Ups and downs in economic activity, which have had limited market impact since the GFC, are likely to become more important – as are the health of individual sectors and companies.

  • Key US leading economic indicators showed some softening towards year-end. But we see this as evidence of a mini-cycle slowdown, rather than signalling a full-blown recession in 2020 -- either in the US or in other large economies. The main exception is the UK, where Brexit-related paralysis may be close to nudging the economy into recessionary territory.

  • Against a backdrop of modest global growth, underpinned by proactive fiscal stimulus, we remain constructive on the outlook for global equity markets and continue to emphasise equities within broader allocation frameworks. But investors should anticipate periodic equity market corrections and outbreaks of volatility going forward. Key event risks that could trigger fresh turbulence include the path towards a Brexit end-game and the run-up to the US presidential race at year-end – particularly President Trump’s trade agenda in the 2020 race.

  • We see most value in Japanese, Asia Pacific and emerging market (EM) equities. We are more circumspect about US equities, where we think some prices may have run up too far and too fast – particularly when it comes to the most expensive technology names and momentum stocks with a growth bias.

  • Meanwhile, the yields on many fixed income securities are simply too meagre to provide effective buffers against equity market volatility. In our view, higher, but relatively steady, yields are available from mortgage-backed securities (MBS), the junior debt of selective UK financial issuers and EM debt. Taken together, we believe this combination should offer fair returns with controlled volatility and, importantly, low correlation to equity markets.

  • We continue to believe that cost-efficient allocations to alternative investments (including gold and real estate) can offer compelling diversification benefits as their value may hold up when equity markets falter.

Developed market credit

Anthony Smouha

  • The search for yield intensifies. Most fixed income securities already yield less than 1%; to capture a 1% yield or higher, we believe investors need to take either interest rate risk or credit risk. One alternative is quality beta, such as subordinated debt from corporates, in particular those in the financial sector. In Europe, Additional tier-one (AT1) securities and contingent convertible capital instruments, known as CoCo bonds, are yielding 4% on average. We feel this is one of the more favourable areas to explore and believe current spreads (circa 390 bps on AT1 CoCos for example) remain highly attractive and could see further upside.

  • Bank or insurance company floating rate notes (FRNs) issued under Basel II or Solvency 1 (often referred to as legacy bonds) have seen significant price recovery. Despite the positive momentum, these legacy FRNs continue to trade at significant discounts; hence, there is still significant upside as the take-out story is far from being priced in. We continue to see significant upside in the whole legacy asset class. As we progress through the grandfathering period (ending December 2021 for banks and December 2025 for insurers), we anticipate we may see the gradual redemption of these old capital securities due to increasing inefficiency of such bonds in those institutions’ capital structures.

  • In particular, we see interesting opportunities within the insurance sector. Ageas, the Belgian insurance group rated A- by S&P, has provided investors with an opportunity to exit a financing instrument stemming from the past. It has done so via a tender offer of old perpetual FRNs – paying Euribor +135bps. These were tendered at 59% (10% higher than trading levels). We believe the price offered significantly undervalued the recovery potential. There has been positive price momentum since and the instruments are trading around 61%. We believe this demonstrates the capability of FRNs to make decent returns. The company replaced the notes with a new restricted tier-one bond issuance in euros with a 3.79% coupon, which has been 6x over-subscribed. The transaction has subsequently traded up to 102.

  • As investors in financials, environmental, social and governance (ESG) has always been an important driver of our analysis. We focus on how ESG drivers impact companies’ credit profiles as part of our fundamental analysis. Clearly, all companies have to become ever more conservative and vigilant in the way they do business and we feel we are moving towards a much more ethical market in general.

  • Looking ahead to 2020, dovishness by central banks and a broader low rates environment bodes well for subordinated fixed income in the financial sector, in our view. It is rather poignant that inflation worries seem to have ceased at the same moment that the great inflation killer Paul Volcker passes on. Investors should remain vigilant, however, which is why we favour interest rate indifference with a low option adjusted spread duration.

Important legal information
Source: GAM unless otherwise stated. The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or advice. Reference to a security is not a recommendation to buy or sell that security. The companies mentioned were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.
December 2019