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Video: Fund manager on how bond markets have reacted to the coronavirus

M&G's Jim Leaviss shares his outlook for fixed income and explains how he expects global macroeconomic themes to impact bond yields.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

  • Bond sectors performed very differently over recent months as investors sold higher-risk assets.
  • Fixed income fund manager Jim Leaviss shares where he has seen buying opportunities.
  • Leaviss considers the impact of the long-term economic themes of globalisation and robotics on the bond market.


Transcript

Emma Wall and Jim Leaviss face their cameras as they videocall from home.

Emma: Hi, I'm Emma Wall and joining me today is M&G's Jim Leaviss to talk about bonds. Hi Jim.

Jim: Morning.

Emma: So what has happened to bonds since the beginning of the year and the onslaught of coronavirus?

Jim: Well, it depends what kind of bonds you're thinking of really.

So, if you think about the safest bonds - Government bonds issued by Germany, Japan, the US, gilts even - they've rallied substantially and pretty much down to their all-time lows in yields as governments and central banks have promised to do whatever it takes. That includes buying huge numbers of government bonds as part of new quantitative easing policies.

Credit and corporate bonds, high-yield and emerging markets has been a very different story.

In March, in particular, people just fled from risk assets. Whether that was equities, or corporate debt, or high-yield. As a result of that you saw the yields on corporate bonds relative to government bonds skyrocketing. At one stage you had the entire US high-yield market trading as if you were going to see pretty much all of it in distress with a high probability of defaults almost everywhere. Since March though governments again have done the right thing. They have stepped in, been very supportive. They've said that they will buy, not just government bonds, but also corporate bonds.

A lot more tranquillity and calm has come back to the market and prices have recovered across the board really.

Emma: Is it a real lesson in why you bother to diversify a portfolio? I'm not just talking about between equities and bonds, which of course, as you say, has provided some buffer, but also within your fixed income allocation because you do get this divergence in opportunity set, and indeed, in performance when you have an event such as this?

Jim: Yes, bonds isn't just one asset class, it’s effectively lots of little asset classes.

We mentioned high-yield bonds which are very risky but have yields of c.10%. Emerging market debt hasn’t really recovered since the March sell-off, because the countries have less developed health systems and tracings are more difficult and so forth. So that's still an asset class with extremely high yields relative to where they were a year ago. There are government bonds, inflation-linked bonds and currencies as well. And if you're a UK investor currencies also provide you with some diversity away from the UK's economic and health prospects so I think it’s important to have a multi-asset approach to fixed income, just as you probably would within your equity portfolio where you don't have all your eggs in one type of equity.

Emma: It's very difficult to tell what's going to happen over the short term, because there is so much uncertainty, but have you been looking at picking up opportunities as there have been these changes in price, and, indeed yields, over the last couple of months, with a view of looking through to the longer-term opportunites?

Jim: If you're thinking about corporate bonds (lending to companies) the most important thing is am I going to get my money back? and “am I being compensated for the risks?

Because there's always a risk. There could be fraud, or something like coronavirus comes out of the blue. You can't plan for that. So you look for companies with strong protections, good assets that you as a bondholders are near the top of the queue for if something goes wrong. You look for good assets behind you and you look for a yield to compensate you for the defaults you expect.

That allows you, as a bond fund manager to even say “I really don't think the prospects in this sector, or for this company, are very good but I'm getting paid something that's implying it's going to go bust this year”. If I know that it isn't going to be the case then you have an opportunity.

March really threw up just thousands of those opportunities because suddenly everything was trading as if the world was going to come to an end. I know it feels like that most days at the moment, but we know we are going to get through this eventually and most companies will survive thanks to existing strong franchises and also thanks for the support from governments.

So what we did in March was really quite heavily buy into credit, into corporate bonds because we have this backstop from the Bank of England, from the Federal Reserve, from the ECB.

The Bank of England is out there every day buying corporate bonds. That really gives you a lot of confidence that liquidity will remain ok. We always have to be careful about liquidity but the liquidity will remain ok, and prices are supported by this huge organisation that can press a button on a photocopier and make more money to buy bonds. There's no limit to what they can do!

So March was an incredible opportunity for bond investors, who invest in credit, to pick up things for the long term, knowing that things may not recover quickly but even if they don't the valuations were right.

Emma: You touch there a bit on what central banks have done how that's impacted the corporate bond market. Can we talk a little bit about government bonds. Unprecedented has become the word of the last three months. When you look at yields on government bonds, we saw things were low a year ago and some of the levels that have been reached over the last three months have just been eye-watering. How do you navigate that market as a fixed income investor when you’re basically guaranteed to lose money at certain levels? Inflation is at 2% and gilts offer you a tenth of that.

Jim: Yeah although we’re going to have a period of deflation, I think that's almost certain now.

Oil prices going negative, inflation is going to fall substantially. Let alone lack of demand, holidays, flights etc. I think the risk at the moment is not one where we're worried about inflation. Further down the line when we come out of here we are going to see months and quarters of the strongest economic growth in history. The rebound is going to be fierce.

All the people are being put out of their jobs are going to come back into the market and we don't who will have the upper hand whether it will be capital or labour at that point.

Maybe labour says “I'm not going to go back to this company that laid me off. I'll go and try and find someone who will pay me more money”.

We don't quite know what the dynamic will be. Maybe there will be some inflation in a year's time or so is something we should think about, but when we think about the government bond valuations every year, every January you see all the forecasts come out from economists, investment banks, asset managers. These have been incredibly bearish every year for 30-40 years now. And every year bond yields have carried on falling. Bond prices kept on going up.

I think if you want to genuinely say “this is time to call the end of a 40-year bull cycle” you have to believe in three things:

First, you have to believe that there isn't still going to be demand for fixed income, these safe assets, income-producing assets. We've got an old, aging population and we know that an aging population needs income and security. We know that people are living longer. Coronavirus may put a dent in that for a year or so, but generally our health experience is one of living longer and being more healthy in our old age. We need some fixed income for that.

I think that trend remains in place albeit with this year being a bit of an outlier.

Secondly, Technology. The technological changes we've seen over the past 40 years have been huge. Internet shopping means that you and I can find the cheapest thing, wherever it is in the world and have it shipped to our house at a price cheaper than the shop around the corner. That's also true for companies like Uber who make taxis cheaper. The technological impact on prices consumer pay has been dramatic. There's also an impact on wages as well. The 'robots stealing our jobs' argument that eventually a clever AI will be able to do our jobs for us, that will put a cap on what we can earn in 'good jobs'. It’s not just manufacturing jobs that have been disintermediated by robots, they will come for the high- paying jobs as well as the low-paying jobs. So that that trend remains in place and may even get more severe, and that will keep inflation low, and bond prices high.

The one I think there is some doubt about is Globalisation. Bond prices have been kept high because inflation is low. That is thanks to China, cheap goods and cheap labour coming to the UK from Eastern Europe. You might say to yourself, well both coronavirus and more quarantine, more insularity, more determination to have your own supplies of goods and food in your own country and not rely on China to produce your PPE etc might put a break on globalisation. Globalisation was already under threat a little bit from Brexit and Donald Trump.

So I think of the three big secular changes. Aging populations, inflation, the impact of technology and trade/globalisation. It's the last one that I might say is going to be a threat

Emma: Jim, thank you very much.

Jim: Thank you.


This video is not personal advice or a recommendation to invest. If you are unsure about the suitability of an investment please seek advice. Investments and their income can fall as well as rise in value and you could get back less than you invest. Yields are variable and are not a reliable indicator of future income. Past performance is not a guide to the future. Please read the key investor information before investing for more details of the risks and charges.

The views in this video are those of James Leaviss and may not be shared by Hargreaves Lansdown

Views correct as at 30 April 2020.



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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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