Jay Sivapalan, Head of Australian Fixed Interest at Janus Henderson, describes how the massive monetary and fiscal ‘welfare’ responses are supporting the economy and providing investment opportunities.

Fiscal ‘welfare’ to bridge the gap

We consider this crisis as an economic ‘stop’ and expect unemployment in the near-term to get to 10-15%. It’s likely to be a very deep, sharp depression-like growth outcome, but a depression of months rather than years. In terms of the fiscal response, this is coming in the form of fiscal ‘welfare’, bridging the gap for those individuals who are unemployed and to support small to medium enterprises.

Looking at the size of the stimulus measures put in place so far in Australia, at 16% of GDP, this is a GFC-style bailout, but rather than bailing out the banks, it’s bailing out society and markets.

Getting back online post-crisis

At a business level, globalised businesses depend on their supply chains, so when a supply-side shock takes place, there can be a prolonged phase of supply disruption. A mobile phone manufacturer, for example, would have a vast number of component suppliers which are vital for their finished product. If 80% of the suppliers were to come back online, while the remainder suffered longer outages or went out of business completely, the entire chain would be broken until alternative sources of supply were found.

At the country level, those countries that come out of the COVID-19 emergency quickest will be quickest to come back online, but they may not be able to open their borders immediately. This means that the domestic economy will pick up before the external sector picks up. If you look at New Zealand for example, due to its vigilance, cafés, cinemas and gyms will likely open up relatively quickly, while their tourism sector may lag until the virus is under control globally, or whole populations can be vaccinated.

These are the sorts of considerations taken into account when assessing investment opportunities, identifying geographies, sectors and businesses with a high likelihood of surviving the crisis and prospering once conditions normalise.

Market illiquidity a key challenge

Looking at markets, it has obviously been primarily in risk-off mode, although we’ve had a couple of days of reprieve. There has been significant volatility and one of the biggest challenges has been liquidity. The liquidity in the Australian bond market has been extremely poor to the extent that along with other fund managers, we have collectively voiced our concerns about a systemic failure of the bond market. That said, we are starting to see some really good pockets of opportunity opening up – particularly some of the higher quality companies. Globally, investment grade credit is down on average about 5%, the high yield market is down about 15-20% and loans are down by about the same amount. Meanwhile hybrids are down about 15%, while equities are down 30-35%.

On the rates side, bonds are starting to be quite anchored because the Reserve Bank of Australia (RBA) has signalled that cash rates will be held at 0.25% for at least the next three years. We’ve observed the RBA buy government bonds and on Wednesday 25 March, also witnessed their purchase of semi-government bonds in scale.

How we are responding

Looking specifically at our Australian fixed interest funds, we have added a significant amount of duration. In the Tactical Income Fund, we had added duration of about 2.25 years, which is the highest we’ve had it in about four years and in the case of the Australian Fixed Interest Fund, we went long duration by about 1.0 year relative to the benchmark, which is the highest we’ve ever had in 25 years of operation. At the time of writing, we had taken profit on most of these positions.

On the credit side, we started to see some really good opportunities. We initially tried to purchase credit beta to gain exposure to broad-based credit. In the Tactical Income Fund, we’ve been buying credit using credit derivatives (CDS). And we had added credit spread duration, from approximately 1.5 years to about 2.1 years. At the time of writing, again we’d taken some profit and look for the next wave of opportunities.

In physical assets, we’ve purchased major bank debt, subordinated debt and other areas which are investment grade proxies for global credit. One of the dynamics that’s playing out here in Australia, (and one of the flaws in Australian bond market) is that our spreads and our pricing are significantly lagging what’s happening in the US. Investment grade credit spreads in Australia on average are up about 100-150 basis points (bps). In the US, they’re almost at 300bps – which is double what we can get in Australia. As a result, we are looking for opportunities to get US-style spreads into our portfolios by buying names that we know the Fed, the Bank of England and the European Central Bank (ECB) are going to be buying. Similarly, we’ve been buying major banks and a handful of high quality corporates, like McDonalds, Coles and Apple, that we are confident will be in business on the other side of this crisis.

Our thesis is that central banks will come through with strong support for markets through this crisis and we’re getting ahead of that. Equally, the default cycle will inevitably rise and as such certain industries and corporates will be downgraded, default and there will be permanent loss of capital.

We are navigating portfolios through what will be a very different economy and structure on the other side of this pandemic.