Fixed income managers less risk-averse despite Covid-19 concerns, says Russell Investments

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Russell Investments’ latest survey of fixed income managers found 50 per cent expect the global economy to revert to pre-pandemic levels by year-end 2021, while 48 per cent don’t expect it to revert before 2022. 

The 64 bond and currency managers who responded to the firm’s Q4 survey also indicated more appetite for riskier assets. 

The percentage of managers selecting investment-grade credit from among 10 options as the most attractive asset class for risk-adjusted returns dropped from 40 per cent in the previous survey to 20 per cent. In contrast, preference for emerging market debt increased 10 percentage points to 15 per cent and high-yield credit increased eight percentage points to 23 per cent.

In addition, fixed income managers expressed more balanced views on regional preferences in the Q4 survey, with 48 per cent selecting the U.S. as offering the best risk-adjusted return potential, versus 71 per cent in the previous survey. The US was followed by Asia (20 per cent), Latin America (15 per cent) and Europe (13 per cent).

“While a second wave of Covid-19 infections and the speed of global economic recovery remain top concerns for the fourth quarter, fixed income managers seem to be less worried about the depth of the global recession,” said Adam Smears, Senior Director, Investment Research - Fixed Income at Russell Investments. “Instead, they appear more focused on the pandemic’s financial impact on specific companies.”

Other key findings in Russell Investments’ quarterly survey, says:

Investment-grade credit: 67 per cent of respondents expect spreads to tighten in the next 12 months (a decrease from 73 per cent in last quarter’s survey), while 30 per cent expect spreads to be range-bound of +/- 10 basis points (an increase from 20 per cent last quarter). Regarding regions and sectors in this arena, managers continue to favour the US and financials as offering the most attractive returns over 12 months. 

Leveraged credit: 54 per cent of respondents expect tighter spreads over the next 12 months (versus 70 per cent last quarter). Regarding fundamentals of high-yield corporates, 45 per cent expect them to improve, revealing a significant change from last quarter when 100 per cent predicted them to deteriorate. In addition, 52 per cent of managers believe that U.S. high-yield bonds should deliver the best risk-adjusted return in the next 12 months. Managers also see energy, retail and healthcare as the areas where credit risk may not be correctly priced in. Furthermore, 67 per cent of respondents expect default rates in the 5 per cent to 8 per cent range over the next 12 months, indicating less panic among managers from last quarter when 50 per cent expected default rates in the 8 per cent to 10 per cent range.

Interest rates: 96 per cent of respondents believe the U.S. Federal Reserve will not move interest rates into negative territory. In addition, 63 per cent expect the U.S. inflation rate will remain in the 1.5 per cent to 2 per cent range over the next 12 months and 53 per cent predict the Fed will achieve its 2 per cent inflation target over the next decade

Emerging market (EM) debt - local currency: Managers expressed a more constructive view on EM currency with about 60 per cent expecting a slight positive performance in the next 12 months (a turnaround from last quarter when 32 per cent expected it to be a detractor in the next 12 months). In addition, managers expressed a preference for the Mexican peso as the most attractive currency in the next 12 months, followed by the Russian ruble. 

Emerging market debt - hard currency: 79 per cent of managers expect these spreads to tighten in the next 12 months, and overall, they express a preference for Ukraine and Mexico as countries with the highest expected return, followed by Argentina and Egypt. In addition, 42 per cent express having more than 15 per cent exposure to EM hard currency corporates, marking the highest percentage since the quarterly survey began. 

Currency: 80 per cent of managers expect the Chinese yuan renminbi to appreciate in the next 12 months, and also reported higher expectations for the euro with 73 per cent saying they expect it to trade in the 1.21 to 1.3 range, increasing from about the same percentage in last quarter’s survey predicting it would range in the 0.96 to 1.1 range. 

Securitised credit: 38 per cent of managers reported they will add risk in the return-oriented securitised credit portfolios in the next 12 months, falling from 50 per cent in the previous survey. Regarding a meaningful beta position, 84 per cent report they already have a long basis in their portfolios, which is up 34 percentage points from the previous quarter. In addition, managers said their top three preferred segments in this arena are credit risk transfer (CRTs), prepayment and legacy non-agency. With CRTs, managers are going lower in quality with 53 per cent reporting they are marginal buyers of lower-quality CRTs.