Fixed income managers are insulating themselves from pockets of risk, positioning their portfolios more defensively as trade tension weighs, the 2020 U.S. elections loom and global growth slows.
“The concern I have around the global economy is you are seeing slowing growth,” said Gregory Peters, managing director and multisector and strategy head at PGIM. He is shifting into higher-quality structured products and retreating from the high-yield space.
“In our active funds, our focus has been a little more defensive. We’ve been a little worried about the trade war, so we’ve been investing in entities less exposed to trade,” said Anne Mathias, global rates and FX strategist at Vanguard, citing health care, medical devices, pharmaceuticals, U.S. utilities and some media firms, among others.
Last week, the U.S. Commerce Department reported gross domestic product increased less than expected in the third quarter, at a 1.9 per cent annualized rate, as trade tensions led to a decline in business investment. The trade war with China, now in its 16th month, has also slowed growth and hiring in the U.S. manufacturing sector.
Although fund managers are showing signs of caution, they do not see recession on the horizon, despite the warning signs in the inverted U.S. yield curve during the summer. A yield curve inversion has preceded every U.S. recession for the past 50 years.
Mathias does not see a recession before the end of 2021; Peters too is looking beyond 2020: “I’m not envisioning a meltdown next year by any stretch.”
Both cited the continued strength of the U.S. consumer as a reason for confidence, as well as demand for U.S. bonds as interest rates fall globally.
Peters said PGIM has reduced risk in credit by avoiding leveraged loans and pulling out of high-yield debt, particularly the most speculative bonds.
Shorting double-B rated debt, the first notch into the “junk” bond space, was a traditional hedge against a downturn, as the best-rated speculative-grade bonds have lots to lose as growth slows. But Peters says trade has been overplayed and is rotating out of that space.
Peters said there are opportunities in single-B rated credits and highly rated structured products. Single-B rated credits are higher risk than double-Bs, but are still attractive as Peters moves out of high-yield debt more broadly.
In structured finance, Peters is moving into higher-rated products.
“We continue to believe the cheapest risk-adjusted asset in fixed income continues to be high-quality structured products. Triple-A CLOs, triple-A CMBS, different parts of the subprime market,” he said. “What we’re continuing to do is shift our portfolios into higher-quality structured products.”