Janus Henderson Investors: Tubthumping (I get knocked down but I get up again)

Key takeaways

• Markets have got back up again thanks to monetary and fiscal stimulus but staying up is an altogether different story.
• For now, we expect technical factors to dominate and support markets but are cautious towards credit in challenged sectors such as real estate and airports.
• While continuing to favour investment grade credit, we believe selected incremental opportunities may lie in dynamic management of duration (interest rate sensitivity) and currencies.

More commonly remembered by its lyrics, the 1997 song ‘Tubthumping’ by British band Chumbawamba topped charts globally, becoming an international hit. The single was one of the best-selling of that year in the UK, US, Australia, Canada, Germany, New Zealand, Sweden, Belgium, and the Netherlands. In the US it remained one of the top-100 sellers again in 1998 too. It has been written that group guitarist Boff Whalley said the song was inspired by “the resilience of ordinary people”.

‘I get knocked down, but I get up again, you’re never gonna keep me down’, were clearly lyrics that resonated strongly then, and today remain a fitting musical analogy that epitomises the way countries and communities have reacted to the impact of the pandemic. Their relevance is no less fitting a description of the behaviour of investors in the aftermath of the ensuing March sell-off.

For investors, it must be said that getting back up has been made relatively easy thanks to the widespread intervention of central banks, mostly adopting a ‘whatever it takes’ attitude to their support of economic and financial market systems (albeit with some variability in response speed and depth globally). Money has never been cheaper, with interest rates held low and likely remaining there for the foreseeable future, and notably in fixed income markets bond repurchase programmes, four months on, have returned most markets to near normal liquidity and pricing conditions.

But, getting back up, and staying up are not the same. The latter requires resilience, adaptability, an openness to continue to learn from the unforeseeable nature of shock events, and an understanding of what it was that laid you flat in the first instance. But before we draw groans for the writing of yet another look back analysis of the March crisis (and specifically the behaviour of global fixed income markets), this piece is rather more focused on the road forward, of the lessons learned and with ‘20/20 hindsight’, the careful evaluation of the things more obvious now that were perhaps not so obvious back then.

Fundamentals versus technicals

At a broad level we have said before that none of the events of the past four months have caused us to change our views about the fundamental health of the issuers in which we invest (and more specifically their ability to service and repay their debt). That is not to say that lower-rated issuers are not at risk of downgrade and default; risks there are heightened, but our general attitude to risk means we rarely if ever dabble in such areas, and in our opinion now is not the time to start.

The world remains in a precarious state. It is vital as investors that we never lose sight of fundamentals, and  apply more focus to businesses or sectors we are exposed to that have been, or are likely to be impacted more greatly by, the continuing economic challenges caused by the pandemic, for example real estate investment trusts (REITS) and airports, where we have adjusted allocations accordingly. However, “don’t fight the Fed” has been said many times before, and we have learned to accept over time the strong tailwinds provided by the widespread monetary support of central banks. At least for the near-to-medium term, markets are likely to continue being driven by, or at least highly supported by, technicals.

Diversification of return sources

While we still believe in the benefits of investment grade credit’s risk versus reward and indeed today the spread over the risk free rate for a highly rated portfolio of shorter dated bonds is almost as attractive as it has ever been, it has always been important to ‘cast the net’ as widely as possible in seeking other sources of return available to fixed income investors operating with a flexible mandate, beyond the reward generated by purely physical assets. This includes an extension of more dynamic management of duration and currency (which has always been a hallmark of our approach), for example:

• Given depressed levels of interest rate volatility as a result of central bank policy, the use of options as a cheap hedge can help serve to protect the portfolio from unforeseen rate moves (in either direction).
• More pointed curve positioning has recently led us to participate in opportunities in the interest rate swap market, where front end carry and rolldown trades look attractive on a risk/reward basis.
• With developed market central banks at or near their effective lower bounds, cross-country interest rate relative value trades provide little scope for differentiation, hence currencies can be an effective tool for expressing relative performance, for example the Euro’s recent outperformance of the USD, as a result of the region’s better handling of COVID-19 and of ongoing fiscal uncertainty in the US.

Particularly within the context of a monetary policy framework which is firmly ‘on hold’ and ‘lower for longer’, constructing a portfolio of uncorrelated positions will be a powerful diversifier of return sources through time. Despite what Chumbawamba sang, we hopefully will not ‘need a whiskey drink, a vodka drink, a lager drink, a cider drink’, nor have to sing a song to remind us of the good times or the better times. But we will certainly drink to the importance of perpetual learning and of building resilience into portfolios.