Industry Voice: It's no secret that there are growing headwinds facing the global economy, but while it is becoming easy to focus on issues such as trade wars and the decoupling of US markets from the rest of the world, we are ever mindful that with uncertainty and volatility also comes opportunity.
While it's important to understand risk and protect a portfolio on the downside, our team believes there is a good case for selective optimism over the coming months.
In this context, a key area we have been adding to is Asia high yield, an asset class we believe was meaningfully oversold in the first half of 2018. This sell-off occurred for a number of reasons, including rising US treasury yields pushing investors away from risk assets, a squeeze in Chinese liquidity coming out of the government's deleveraging effort, and further risk-off sentiment driven by Trump's ‘trade war'.
However, these reasons to be fearful are only one part of the picture, and we are also seeing some present cause for optimism. Chinese monetary policy appears to be loosening, which is likely to boost the liquidity of commercial banks and in turn benefit the high yield bond market. Technical factors also appear to be turning the corner, with new issuances being met with strong demand as global flows into the asset class increase. Despite spreads returning to mid-2016 levels, a 40% increase so far in 2018, fundamentals are still looking strong with leverage continuing to fall and credit ratings improving. Relative to other high yield regions Asia is attractive, with spreads in Euro high yield widening only 25%, and US high yield experiencing no spread widening.
For some time now, emerging markets local currency debt has been more favourable than USD denominated bonds due to the strong dollar, and the resulting higher funding costs for issuers. But we have recently experienced a pick-up in yield and quality by adding back to hard currency debt, based on our view that these bonds have been oversold. Given we want to be defensive as well as look for yield, we like the USD duration exposure that this allocation provides.
We also see positive prospects for financials, although we remain cognisant of the regional and asset class nuances in this sector. In the US, after a long period of regulatory headwinds, bank stocks are back to growing their dividends (a key consideration for income funds) in what has been a sustained period of growth in the US economy, with rates continuing to rise. In terms of fixed income exposure to the sector, we think European financial bonds are positioned positively, with deleveraging continuing to improve balance sheets, and the rate of non-performing loans still declining.
Although we have seen strong performance from alternatives so far this year, we are mindful of the politically sensitive nature of some investments, such as private finance initiatives in the UK, and are positioning ourselves accordingly. However, given this late cycle environment we still like the asset classes' low correlation to traditional markets.
Overall, the path of selective optimism is an important balancing act at this stage of the cycle. While opportunities are still presenting themselves, we are watching carefully how various headwinds develop moving forward. In the meantime, we look to maintain defensiveness to preserve capital, as well as look for opportunities for income generation and capital growth.
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This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The value of investments and the income from them can go down as well as up and investors may not get back the amount invested. Investments in overseas markets, changes in currency exchange rates may affect the value of an investment. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Investments in small and emerging markets can be more volatile than other more developed markets. The Fidelity Multi Asset funds use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This article may not be reproduced or circulated without prior permission. Issue d by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0818/22445/SSO/NA
