April 09, 2020


Welcome to the recap of our Covid-19 weekly webinar – we hope you and your family are safe and well.

 

On Thursday 9 April, our Investment Solutions specialists Rupert Watson, Head of Asset Allocation, Paul Cavalier, Head of Fixed Income research, and Andrew McDougall, Head of Portfolio Management, Investment Solutions, hosted a webinar on the latest investment implications due to coronavirus. 

What’s happening?

Since our webinar last week, financial markets have rallied strongly, with equities making back around half the losses they sustained some three weeks ago. This “violent recovery” has occurred as markets are looking forward to when, where and how we might begin to see a global recovery from the Covid-19 outbreak.

 

However, before we get to that point, we believe there are some difficult times ahead, best illustrated through the following numbers from the world’s largest economy:

 

There is some optimism, however. Italy, where the European outbreak started, seems to have just passed its peak of new infections and deaths, which is encouraging for other countries – such as France, Spain and the UK – that are trailing its trajectory by a week or two.

 

Elsewhere in Europe, Denmark and Austria are set to reopen some shops and schools, estimating that the worst might be over for them, too.

 

However, even if there is some good news, the path ahead is still liable to further disruption. Scenarios from Morgan Stanley[4] show that the US – now the global epicentre of Covid-19 – recovering by the autumn and resuming even close to normal activity are contingent on antibody tests, vaccines and a coordinated approach to widespread virus testing. And even in the most optimistic scenario, we could very well witness a second wave of the virus hitting major economies just before Christmas.

 

Opportunities ahead

But where there are massive market dislocations, we believe there are opportunities and we have spoken over the past few weeks about the prospects for high yield and some investment grade credit. While spreads over government bonds have narrowed a little recently, we continue to see value in these sectors and investors should plan how to take advantage of any further dislocations in credit markets in general.

 

Our current view is informed by our experience in the 2008-9 financial crisis and other historical market events.

  • High yield can be very well rewarded for the risk taken, even taking into account defaults and so-called “fallen angels” 5
  • High yield debt has widened to around 900 basis points over government bonds since the start of the pandemic as shown by ICE Bank of America data5
  • Investment grade credit has also widened against their government counterparts and represents good value
  • These sectors should also be well supported by government and central bank action, in our view.

With this in mind, we see these two categories earning meaningful returns over the next three years, especially in high yield. Within our own portfolios, we have reduced our sovereign holdings and increased corporate credit, taking care to manage what sectors we hold and to avoid fallen angels, which face substantial price volatility. We explore this in more detail in a recently produced paper (“Time to buy high yield debt”, Mercer, 30 March 2020). We have found liquidity issues to have eased from tensions a few weeks ago and continue to advocate active management in this sector, which hopefully will avoid many of the more troubles issuers.

 

About Mercer client portfolios

Within a number of client portfolios, where we have been given discretion, we have moved to an overweight of between 6% and 8% across sub-investment grade debt (as at 9 April 2020). The decision was informed by our vast research capability and intellectual capital. Of this, we have moved the majority into a BB/B focussed high yield bond strategy, which because of its daily liquidity enabled quick execution. We have allocated the balance to a target overweight in multi-asset credit strategy, which we believe offers broader diversification across sub-investment grade credit by targeting assets such as (but not limited to) banks loans and securitised assets, in addition to high yield bonds.

 

We also have a positive view on investment grade credit, increasing the allocation by 5% in a typical client portfolio. The credit spread over government bonds – up to 2.5 times usual levels – means we consider this offers substantial compensation for any potential defaults. Both the wide geographical variety and double digit returns we expect investment grade credit to produce over a three-year time horizon, in recent analysis by JPMorgan, means we believe they offer good value for our client portfolios[5].

 

To fund all these allocations, we have sold out of a combination of cash, lower risk investments like absolute return fixed income and other parts of the growth fixed income segment including local currency emerging market debt.


What’s next?

Markets first stabilised thanks to central bank and government support and they are now rallying by taking a long-term view. For the moment, however, we have no firm outlook on the short-to-medium term and continue to rely on our research teams and analysts to inform all our decisions.

 

[1] US Department of Labor, April 09, 2020

[2] As of 9 April, 2020

[3] As of 9 April, 2020

[4] As of 9 April, 2020

[5] As of April 9, 2020


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