Key takeaways

• Our credit style of ‘sensible income’, essentially a quality filter, has served to underpin the credit exposure in our portfolios in recent weeks.
• Our general view is that the coronavirus incident provides an opportunity to selectively add risk, given our relatively defensive strategic asset allocation.
• We view the recent market moves as the culmination of a decade-long regime in which quality outperforms value, driven by a lack of structural growth, ESG and now compounded by a cyclical global collapse.

A sensible income strategy

Our credit investment style of ‘sensible income’, essentially a quality filter, has served to underpin the credit exposure in our portfolios during the coronavirus incident. We hold no commodity bonds, no Italian or emerging market corporates, no airlines and no autos. What the filter does not do is protect us against generic spread widening in the corporate bond market, which has been significant. Monday (9 March) was one of the largest days of spread widening on record.

For example, taking the case of the global high yield (HY) market, there are over a trillion dollars of bonds in the index, which we would not consider for investment.

Source: Janus Henderson Investors, February 2020

Note:     OEMs = original equipment manufacturers

Coming into this incident, our credit asset allocation was the most defensive it has been in our 16 years of running strategic portfolios (as proxied by the high yield exposure in the asset allocation chart) but also a record low subordinated financial weighting too, as shown in chart 2.

Rejecting the industry narrative

Since 2017 we have been actively de-allocating from riskier credit and preferred investment grade and government bonds. This has clearly been counter to the industry narrative of a ‘government bond bubble’ and, we argued, illusory ‘value’ in illiquid and risk areas of the credit market.

Source: Janus Henderson Investors, desk classifications, as at 31 January 2020

Note:     Quarterly data points up to September 2009, monthly data points thereafter. Based on a representative account, which is believed to most closely reflect the current portfolio management style.

Must not overlook the opportunities

Our general view is that the coronavirus incident provides us an opportunity to add back suitable credits (which fit our style) at an attractive yield for the first time in a number of years. Though this would be selectively adding risk, given our relatively defensive strategic asset allocation.

We have been using the sell-off in credit as an opportunity to begin adding back credit risk, albeit being fully aware that the next few weeks will be a challenging time from a news flow perspective and markets are quite likely to roll down to even lower levels. This is the beginning of an averaging in process and we need to get going.

When we do come out of the coronavirus ‘recession’ we will be in a world of ‘zero interest’ rates across the entire developed world; central banks buying even more investment grade corporate bonds via quantitative easing, a stumble towards fiscal stimulus and a cleansing of the ‘value’ areas of the credit markets that have been zombies for years (high yield energy being the most obvious example). As a result, I would not be surprised to see even lower yields on quality corporate bonds by the end of the year than where we started.

This is not 2008

It is important to state that there is a not an endogenous sickness in economies or markets, which will leave scar tissues and take years to fix as was seen with the banks or the telecoms, media and technology (TMT) debt issues in previous cycles. There is also not a moral hazard issue as a result. Central bankers will, in my view, ensure that a global health crisis does not become a global liquidity crisis for on-the-run corporate investment grade credit. Private debt and collateralised loan obligations (CLOs) however, are a different matter.

I view the recent market moves triggered by the coronavirus as the culmination of a decade‑long regime in which quality outperforms value driven by a lack of structural growth, environmental, social and governance (ESG) and now compounded by a cyclical global collapse. It may well be the end of the government bond bull market with the final developed economies of the US, Canada and Australia falling back into the world of zero interest rates. From where we stand, I believe that there is little value or opportunity in government bonds other than as a short‑term hedge to risk assets.

What we can say is that the future need for sensible income will be more severe than ever.

We believe our portfolios are in good relative shape after several years of solid performance. Credit markets are suffering a severe sell-off in the short term for justified and obvious reasons. We expect significant outflows from funds which have been too highly exposed to riskier areas of the credit markets and view this as a potential opportunity to invest in corporate bonds that fit our style filter and a sensible yield.