Letter to investors
As 2020 approaches, the uncertainty in the market has receded but there are still risks ahead involving macroeconomic, political and technical factors. Under such a scenario and with central banks being accommodative, we do not envisage a major increase in European core bond yields from their current levels given the limited growth potential and the scarcity of tools left in the ECB’s toolkit to stimulate the economy. Should the economic situation deteriorate, there could be room for yields to fall, but probably not to the lows reached in late August/early September.
Next year the ECB will play a crucial role in market liquidity and the financial sector, with its new two-tier banking reserve system and TLTROs boding well for subordinated financial bonds, which are a favoured instrument in the hunt for yield. The central bank will also support credit markets with its recently relaunched purchasing programme. Evidence from the first few weeks of QE2 suggests that the ECB will increase the proportion of corporate bonds in its overall asset purchases, supporting the corporate bond market.
Regarding our key investment convictions for 2020, we believe that alpha will be generated mainly using tactical strategies on duration and curve trends until clearer signals on the market direction allow investors to embrace a more strategic view. Government bond yields are likely to remain stagnant. In a low-growth scenario, investors seeking flattening positions should chase any available premium. Additionally, government bonds from countries that trade at large spreads versus core countries will remain attractive. Inflation-linked bonds are cheap and could be worth pursuing, should headline inflation move higher.
The prolonged monetary policy easing of the main central banks will support the entire credit spectrum and investors will likely favour the European segment in their search for yield rather than other geographies, due to its better fundamentals and valuations. In the Euro investment grade space, we prefer bonds that benefit from positive carry. We are positive on the Euro high yield segment, with a focus on cyclical names should trade tensions ease. In the financial space, we favour CoCoand lower Tier II bonds. We are mindful that greater scrutiny is needed on liquidity for the higher yielding sectors in 2020.
In any investor’s portfolio, Euro fixed income offers diversification and stability under our central 2020 scenario. Investors could play the “core” component of their Euro fixed income portfolio with a focus on aggregate strategies that can play duration flexibly, together with yield curves and cross region/sector allocation. Investors could also play a satellite allocation to enhance income through high yield and subordinated bonds, as well as a continuum of listed and public debt.
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