A Constructive View on Fixed Income Opportunities

When you look at the current macro environment and what it means for risk assets and fixed income, “it’s been simplified, dare I say it, to the letter of the alphabet: is it a V, W, U or L economic recovery? Our view is that we’re in a base case of a W-shaped and, important to note, an upward sloping W-shaped recovery,” said Chris Wilson, CFA and Senior Client Portfolio Manager at Voya Investment Management, at Pensions & Investments’ Fixed Income & Credit virtual series. “While we saw some pretty spectacular growth numbers for the third quarter, we don't think we're fully out of the woods. There'll be fits and starts, even with the fiscal stimulus that's certainly a catalyst which can add some volatility along the way. But the overall economic picture is broadly supportive, in part with GDP expectations and anchored by a supportive monetary policy with what is effectively a zero interest rate policy from the Federal Reserve.”

There was considerable cash on the sidelines as investors moved to risk off in the early days of the pandemic, noted panelists at the session titled, ‘Risk On? What Strategies are Providing the Best Opportunities and How to Set Parameters.’ “It’s not just cash in investor's pockets, but it's also cash on corporate balance sheets,” pointed out Wilson. “While some were worried about an explosion in corporate bond issuance, the important thing is what they did with those proceeds with the combination of extending maturities and allowing cash balances to grow to stabilize balance sheets. We believe that cash is that fuel for future growth as well, which will continue to allow a constructive view on market opportunities going into next year,” said Wilson, who is also a member of the multi-sector fixed income team at Voya.

“As we think about the U.S. credit sectors and leaning a little more on the public fixed income side, and we just start with a quick review at a combination of spreads and duration, you are automatically drawn to further down the capital structure in CMBS (commercial mortgage-backed securities). That means triple-B rated CMBS , followed by high yield,” said Wilson. Another area that mandates exploration for opportunities in portfolios are dollar-denominated emerging market sovereigns, he recommended.
Some opportunities remain in non-agency debt, although there’s been a significant retracement in that part of the market, and it is not as intriguing as it was earlier in 2020. Also, private credit investment grade and high yield can be interesting, with good quality, structure and premiums above their public counterparts, he added.

“That being said, permit me to chase my tail for just a second. Within the CMBS franchise, from the perspective of the K economy and its notion of winners and losers, we think security selection will be a greater than normal opportunity in the months ahead,” said Wilson. “We've had some great news as it relates to vaccines, and have seen a little bit of cyclical and sector rotation. Nonetheless, we think that the next move will be a further delineation of winners, losers, but also survivors. Bond investors love a winner as much as our equity colleagues, but in the land of fixed income, a survivor means you're still going to get par back. And particularly within CMBS, the sector is being largely regarded as nothing but losers and we disagree.”

Individual security underwriting offers plenty of opportunity across the CMBS landscape, said Wilson. “If you look at the winners alone, that would be industrial-oriented properties being used to support the logistics of e-commerce and online retail operators, and they're in huge demand right now. Within the office space realm, that’s life sciences. While many of us are working from home, if you're working on a vaccine or a therapeutic, you're probably working in a lab and going into that office. There’s also a glimmer of hope within retail, that being grocery-anchored retail, because that’s the one retail habit that has substantively changed, we're all doing a lot more grocery shopping. So it's that brick by brick approach, and you can be nicely rewarded for conducting that type of research,” he said.

“A lot of EM countries have taken advantage of very easy monetary policy from the big three—the Fed, the Bank of Japan and the European Central Bank—and they’ve joined in the rate cutting party too, so their currencies have eroded a little bit,” said Wilson, on why dollar EM debt is preferred over EM local debt. “We do think you can look at EM local tactically for currency opportunities, and do some tactical hedging as well. But broadly, we continue to like emerging markets because one of the key ingredients to resolving the challenges from Covid is growth. EM countries have a structural advantage over developed countries as they have higher potential growth rates and so they'll be able to recover more quickly. Importantly, it doesn't matter where the global growth comes from: U.S., Europe, China. The exporting countries across the EM landscape will quickly redirect focus there to take advantage of it.”

From a manager’s perspective, the challenges around due diligence and on-site and country visits that are not possible in the global pandemic have meant more remote video engagements and more virtual introductions with prospective and existing clients, Wilson said. “We've seen firsthand the peer-to-peer conversations in that we had a client who was just embarking on some deeper due diligence across a pretty large mandate, and they just felt stuck. They had met with folks on the video cameras, but there's that element of being able to look someone in the eye, in person, that they couldn’t do. So we found ourselves introducing prospects to existing clients, who were able to share that information or additional insights that would have typically been gleaned from a traditional in-person due diligence initiative.”

With the resurgence in Covid infections globally, how can investors position themselves against potential future shocks? “Away from what we call the cash bond opportunities, we think about what type of tactical strategies might you be able to implement as a way to buffer the portfolio with any unexpected types of volatility.” he said. While the number of Covid cases have grown exponentially and hospitalization rates are at high levels again in certain parts of the United States, there is some comfort in the current trends that it’s taken longer to get to these levels and that fewer people, as a % of total cases, are requiring hospitalization. “Also, the cash bond you may elect to sell to tactically take risk down a bit today may or may not be available for purchase in the future when you want to add risk back,” Wilson recommended. “So whether it's looking at things like buying CDX as a way to protect the portfolio, as well as options on certain currencies or even VIX, that would be prudent. It’s the combination of those two strategies that we think is probably not a bad combination for this type of environment,” he said.

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Nothing contained herein should be construed as (i) an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Voya IM assumes no obligation to update any forward-looking information. Actual results, performance or events may differ materially from those in such statements.