At the Janus Henderson Global Media Conference, “New Investment Paradigm: Uncovering Opportunities and Challenges,” our senior leaders and key portfolio managers from around the globe shared their insights and outlooks for their markets. In this session, Head of U.S. Fixed Income Greg Wilensky joins Portfolio Managers Jeremiah Buckley and Michael Keough in a discussion on the importance of building diversified portfolios to provide resilience regardless of the economic environment.

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Louise Beale: I’m going to move on now and we’re going to discuss how we balance opportunities and risks in a portfolio, and for that can I introduce our host for that session and that is Erika Oquist, Senior Product Specialist at Janus Henderson Investors. Erika, please do introduce us to your panel.

Erika Oquist: Thank you, Louise. So joining me today are the three co-portfolio managers on the Janus Henderson Balanced strategy. We have Jeremiah Buckley who is our lead on the equity sleeve, and our two fixed income sleeve managers, Greg Wilensky who is also the head of our U.S. fixed income business, and Michael Keough. So today’s discussion is focused on balancing opportunities and risk, so let’s kick it off with the opportunity. Jeremiah, my first question for you is, has the pandemic changed the trajectory of the trends that were driving earnings growth prior to the pandemic?

Jeremiah Buckley: Thanks, Erika. Yes, a number of trends have accelerated post pandemic. We believe the shift to ecommerce has truly accelerated. The increase in penetration of ecommerce relative to physical commerce we think has been pulled forward by a couple of years and a lot of the habits that were formed by consumers through the pandemic have been cemented through this period. This acceleration in ecommerce will eventually also lead to an acceleration in e-payments penetration as soon as travel spending recovers on credit cards, and that is great for all the companies that are playing in credit card networks and facilitate that transition.

The need to work from anywhere and consumers’ desire to entertain from anywhere has also accelerated the demand for cloud services and software solutions that drive digital capabilities for companies. We also believe that companies that have scale and the balance sheet strength who have made investments throughout this period and prior to the pandemic to transition their business to a digital economy have seen market share gains that would’ve taken multiple years to achieve in a more normal environment. So we definitely believe that a number of trends have been accelerated and are driving good economic and value creation.

Oquist: Thank you, Jeremiah. So, Greg, my next question is for you. So why should investors keep bonds in their portfolio?

Greg Wilensky: Thanks, Erika, and I’m sure part of the underlying question there is a view around interest rates. So let me start by noting that given our economic forecast I do expect yields to be rising over time, although not at the pace that we saw in the first quarter. This clearly does create a bit of a headwind from a total return perspective. As a result, we’re running less interest rate risk in the portfolios that I manage. But let’s also remember that while it’s already really challenging to forecast the destination for where rates will end up, it’s even harder to accurately predict the path that rates are going to take to get there, especially with all of the uncertainty, pandemic and otherwise, that exists right now.

This is the reason, frankly, this difficulty in predicting both the destination and the path of rates that those of us who have been managing money for many decades know that we can consistently add more value and generate better risk adjusted returns by typically allocating or focusing a larger share of our active risk budget on relative value calls, one sector versus another, one company versus another, relative curve trades, than on those outright market calls.

Also, thinking about how investors use fixed income in their overall asset allocation, not only do they want to generate income and return, but they’re also using it to manage the overall volatility of their total investment portfolio and provide that downside protection and diversification in stressful market environments. So therefore, we think that modestly reducing the interest rate risk within your fixed income strategies in the current environment makes more sense than making a wholesale allocation change.

We think this is the right choice, especially given the uncertainty, and this is especially true when your fixed income investments are being managed by an active manager that you have confidence in. We are regularly updating our economic views and just like we did last year during the pandemic when risk started to spike up, as well as then when policymakers responded forcefully and our views changed, we were able to nimbly respond to the risks and opportunities that the market presented to be able to protect during the down trade and participate in the up trade, and that’s exactly what we look to continue to do during 2021 and beyond.

Oquist: Thanks, Greg, and you really bring up a really important point of why active matters and why it is so important to have an active fixed income manager to really help serve as that balance to an investor’s overall portfolio. So pivoting back to equity, Jeremiah, are you finding valuations in the more simple sectors that have performed well over the last couple quarters still attractive?

Buckley: Yes, thanks, Erika. This is another area where it really is important to be active because the answer really varies by sector. We think that there are a number of areas that definitely fully reflected the recovery and then some, so there’s some risk to those valuations, where in other areas we think there are opportunities for growth to accelerate and so we still see some attractive investment opportunities.

A few sectors to comment on, I’ll start with banks and consumer finance companies within financials. They’ve seen their valuations more than fully recover, but we think it’s still hard to argue that the long-term growth outlook has improved. So there could be some risk if interest rates don’t continue to expand or if consumer credit doesn’t continue to improve. There could be some risk to the valuations in this sector.

I think the same could be said for parts of the materials and capital goods space as well where valuations are now well above where they were in 2019 due to the rapid rise in economy prices. But we think there continues to be a lot of uncertainty around whether the current supply and demand imbalances will persist in 2022 and beyond, so we think it’s really prudent… You need to be very careful when looking at different names within these sectors.

However, a couple of areas where we continue to see opportunities, though, would include industrials where we believe we’ll see an acceleration in spending on supply chain infrastructure, as well as autonomation of manufacturing going forward, which has created a lot of opportunities for a number of industrial companies catering to these trends and we think that this potential growth acceleration that we could see in the years to come may not be reflected in the stocks today.

And then lastly, while valuations in consumer discretionary have also more than fully recovered since 2019, we continue to believe that consumers are in a great position to continue to spend given significant pent up demand and very strong consumer balance sheets, record consumer wealth based on strong housing prices and capital market prices. So we think this may be another area where the valuations don’t fully capture the potential growth and we continue to see opportunities but, again, you need to be careful. You need to be selective by sector. You can’t just go into all cyclical areas.

Oquist: Yes, I think that’s a good segue into discussing some of the opportunities within fixed income. So, Mike, what are some of the areas of opportunities within credit and securitized where there’s potential for both income and capital appreciation?

Mike Keough: Yes, absolutely. I’ll start by saying within the fixed income or in the debt markets you have a lot of fixed income sectors that you can allocate to based on your outlook. We’ll acknowledge that given where overall yields are and spreads today finding both of that income and capital appreciation is there’s definitely some tension in being able to do that. I’ll start by saying we think the areas where you can generate both of those will be much more in the credit spread sectors. Those will include corporate securities as well as securitized securities, such as asset backed or even commercial backed securities as well.

If you step back, I’d say that you have to look at where we are in the economic and credit cycle, and we’re still very early innings. What you see is a strong improvement in fundamentals as the economy reopens, so we’re really focused on finding some of those securities that are going to benefit from improving economic and earnings growth or have support of strong consumers and record savings rate.

So while we’re focused there, fundamentals form the foundation of our view. I’d also say that valuations are extremely important in finding those areas where you can generate those returns. When you look back, if you just look at the overall spread factors from the top down, you’ll see that valuations have priced in much of that strong economic and fundamental outlook that I just mentioned. We have spreads that are back towards [unclear] before we entered the crisis early last year and so a lot is priced in. With that said, there’s always areas that we use our research to try to find opportunities and a couple that I’ll point out.

First, high quality, high yield securities. What you’re benefiting from there, they have additional spread. That gives you some of the income that you need. Then I think the other thing that we’re benefitting is you look at the higher quality part of the high yield market, we’re seeing record low default rate estimates, below 1%, and so you have… That’s reflecting some of those improvements in fundamentals, so that’s constructive. On top of that we also have… We’re at the beginning of a ratings upgrade cycle where a lot of corporations are focused on improving their balance sheet, higher credit ratings which result in lower spreads as well.

I think the other area that we’re also finding some opportunities is exposure to the consumer, record savings levels and generally in a strong position as jobs recover. We’re finding opportunities in the securitized space. Some of those either shorter duration securities and in some capacity also floating rate securities. So those are a couple of the areas that we’re finding that balance where you can generate some of that income and then we do see [unclear] coming from spread tightening.

Oquist: Okay, thanks, Mike. So on the risk front, Jeremiah, a question for you. What risks are you considering that could impact potential for continued capital appreciation in equities going forward?

Buckley: Yes, Erika, we’re continuing to monitor a number of potential risks that might impact corporate earnings growth going forward. I’ll list a couple. We continue to monitor the risk of input cost inflation, as well as labor inflation and contemplate how that will continue to impact corporate margins. We’ve had a substantial improvement in corporate margins over the last number of years and so these factors we need to continue to be able to monitor. We need to continue to invest in companies that we think have pricing power because of the value proposition that they provide.

But that’s one area of risk that we need to pay close attention to and make sure that this inflationary pressure is indeed transitory instead of structural. We also continue to contemplate the impacts of tax reform and what that might mean for consumers, as well as corporations and how bad it will impact consumer spending. Both Mike and I have talked about our excitement around consumer spending and pent up demand, but if tax reform takes away some of that dry powder that they have, that could impact consumer spending and will have follow-on effects as well.

And then corporations, if tax reform leads to higher corporate rates, that’ll impact their return to shareholders. That could impact the capital spending that they do for the next couple of years and so those are areas that we need to continue to monitor and make sure that the benefits with the offsets to that tax reform are productive.

Lastly, global supply chain and trade disruption continues to be a worry of ours, which was also a worry prior to the pandemic. There are a number of countries, manufacturing countries across the globe that are still hampered by COVID. Geopolitical tensions are still very present and so those areas are where we continue to monitor some of the risks.

Erika, that’s why we believe it’s really important to focus on companies that are generating strong free cash flows today, have been investing in their business to adjust to this changing world, and investing to make that digital transition and make their business more profitable and solid for the future that we see. We believe that these types of companies will be able to weather those risks and the volatility to come, but that’s where we continue to be focused, Erika.

Oquist: Great. Thanks, Jeremiah. So my next question is for you, Mike. It’s no secret that central banks have been extremely important to the market and economy over the last 18 months. So with the recent Federal Reserve meeting last week, could you discuss that and how it’s shaping the outlook for markets?

Keough: Yes, Erika. It’s a really topical question of what’s been going on the last couple weeks here and I’ll start by saying if you look at what the Federal Reserve did last year, they stepped in so quickly and with so much accommodation and force that they were really able to input or implement those emergency measures and put stabilization into the markets, got the economy moving and some conditions for corporations to borrow, the economy, just give time for it to start healing. That was all really needed and really important. Those were emergency measures. Today, we’ve made a lot of progress.

We’ve had the stabilization in the markets. The economy is beginning to see some of that recovery. Vaccination rollouts have proceeded very well in the United States, and corporations have remarkable access to capital in the market. Yet despite all that, those emergency measures still remain in place and so one of the important things that came out up out of the Fed meeting last week was they began to discuss the process of removing parts of that emergency accommodation, specifically beginning to taper… The discussions around tapering some of the quantitative easing, purchasing mortgage backed securities and U.S. Treasuries.

So that’s important. We agree with that. We think that’s the next step to be taken. But then I think it’s important to bring up one other thing that came up in that market. It was a bit of that taper talk and then the next part of it was, what’s going on with the [unclear]? We did see some Federal Reserve members increase their probability or expectations of a rate hike in 2023. We generally thought that was expected in the markets, that was our view, although there was a little more of a reaction than we expected.

I think one thing is important to note. The beginning of removing some of those emergency measures is just that. It doesn’t change the fact that the Fed expects and we expect that interest rates will remain near the zero bound in 2021 throughout 2022 and so don’t lose sight of the fact that there’s going to be a remarkable amount of accommodation by the Fed to ensure we are able to execute on some of that substantial further progress that they’re expecting.

I think one thing is important to note. The beginning of removing some of those emergency measures is just that. It doesn’t change the fact that the Fed expects and we expect that interest rates will remain near the zero bound in 2021 throughout 2022 and so don’t lose sight of the fact that there’s going to be a remarkable amount of accommodation by the Fed to ensure we are able to execute on some of that substantial further progress that they’re expecting.

Oquist: Thanks, Mike. Just one last question before we open it up for Q&A. Greg, so building off of Mike’s comment, how do you factor in the level of uncertainty around the path of inflation creates monetary policy into the construction of a core bond strategy?

Wilensky: Well, first, you start by being humble. I think that’s most important. You have to have humility about your ability to accurately forecast things, like economic outcomes, election results, policymaker decisions, because, frankly, even if you can forecast that right, then forecasting how the market will react to these events is still a real challenge. Next, in building your process, you should be measuring your forecasting accuracy, doing performance attribution over time. This is a good way to both remain humble as well as determine the areas that you demonstrate strong forecasting prowess.

You then have a disciplined investment process that allocates more risk over time to the things that you do well and you look for ways to improve the areas that you aren’t doing as well. And then really important, you diversify. We know that we can generate better risk adjusted performance for our clients over time by allocating risk across a larger number of investment ideas driven by independent analysis than by putting all of our proverbial eggs in one basket and betting on a single economic forecast.

Essentially separating out from just this interest rate call, really focus on what Mike was talking about and Jeremiah was talking about, about generating excess returns regardless of what happens with treasuries. That’s what we’ve shown the ability to do time and time again and we’ll continue to do that. So, in short, you develop a disciplined repeatable investment process by generating research insights across a broad range or a broad cross-section of the entire fixed income investment universe and you build diversified portfolios that are going to provide resiliency across a range of economic scenarios. That’s what we think is the key to long-term success in managing core bond portfolios, regardless of the economic environment.

Oquist: Great. Thank you, Greg. We have just under two minutes left here. There’s a question that came in from the audience. Jeremiah, I’m going to put this one to you. How are you looking at the travel and leisure subsector today and going forward?

Buckley: Yes, thanks, Erika. The travel leisure sector was a great growth sector prior to the pandemic. Obviously, that’s significantly changed through the pandemic.

But what we’re seeing in travel and leisure is we’re seeing the domestic leisure travel market, particularly in the U.S. which we know best, is close to fully recovered, but obviously some of that has been pent up demand because people couldn’t travel last year and so they’re anxious to get out and travel today. We’ve seen a slower recovery and not a full recovery in international and business travel, but we believe that that will eventually get there. We’ll need some growth to offset some of the meetings that have been replaced by video meetings over time.

But in looking at investing in this sector, we think this is another area where you need to be very selective and active management really matters because there are some companies within the sector that already fully recovered their full valuation plus more, even though they’ve added substantial amounts of debt to get through the pandemic. So we think that investors really need to be careful in looking at some of those companies where the enterprise value is much bigger than it was going into the pandemic.

However, we continue to find some businesses that had much better balance sheets and have better business models and they were able to weather the storm of the pandemic much better. We believe that the investments that they’ve made in their businesses, in their people through the pandemic will allow them to gain meaningful market share as we come out of this, as some of their peers or competitors will be focused on deleveraging their balance sheet through that period of time. So we do find attractive opportunities but, again, it’s really important to be selective and understand how the balance sheets within the investments that you’re looking at have shaped up throughout these last couple years.

Oquist: Thank you. All right, we are up on time. Jeremiah, Greg, Mike, thank you so much for your time today and, Louise, back to you.

Beale: Thank you very much, Erika, and to your panel. Some really fascinating insights there. We appreciate it.