Many thought 2020 would be an interesting year for financial markets but most will admit we got more than we bargained for.
The spike in uncertainty and volatility that has accompanied the COVID-19 pandemic has many investors reassessing investment portfolios and their views on various asset classes. Below we will explore some reasons why investors can feel comfortable in building a fixed income allocation in the current market.
In addition to the yields/valuations now on offer, the Australian government and private sector response to COVID-19 are very supportive of credit fundamentals, and those building a portfolio now can do so through a COVID-19 lens when targeting companies and sectors.
Let us begin with valuations now as opposed to pre-COVID-19. Credit spreads have come right back down from the peak stress of March but they are still higher than pre-COVID-19 levels.
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What this means is that investors are being paid more now to lend to corporates than they were pre-pandemic. Obviously there are sectors and issuers in these buckets that are riskier and face a more uncertain outlook, but in general investors are now able to achieve higher yields than they were at the beginning of the year.
So investors may be able to get more for their money now, but we must of course assess this in the context of the broader environment?
Comparatively, Australia has had a very effective government response to COVID-19 in terms of closures/restrictions as well as fiscal stimulus which is limiting the economic impact and positioning our markets for a faster rebound.
- Victoria is facing a challenging period with approximately 75% of our confirmed COVID-19 cases, but state and national level measures put in place do appear to be working with close to zero new cases reported elsewhere in recent days. Further, as a measure of total cases per capita, Australia is one of the best performing countries in the G20.
- Fiscal stimulus for households and businesses has also been very supportive. Between JobKeeper, JobSeeker, increased social assistance payments, debt relief, and early withdrawal of superannuation, there has been substantial assistance for household cashflow which is benefiting our local economy. Australia’s government packages as a share of GDP sit in the top quartile of the G20 and all but one that has provided greater support are doing so under greater stress of new cases.
Companies in the private sector have also taken steps to strengthen their balance sheets and maintain liquidity, including raising new equity, cutting or deferring dividends, and reducing capital expenditure. According to Bloomberg, in Australia, April saw over 60 companies offering a total of AUD 11 billion in equity placements which is larger than any other month on record, including throughout the GFC. This pattern was replicated globally.
Many issuers have implemented a combination of these measures, all for the purpose of protecting the companies’ credit profiles at the expense of equity holders.
- Sydney Airport (infrastructure) – equity raise & dividend cut
- Qantas (airlines) – equity raise & dividend cut
- All major banks (financials) – equity raise & dividend cuts
- Lendlease (real estate) – equity raise
- QBE (financials) – equity raise
- Ramsay Healthcare (health care) – equity raise
- Cochlear (health care) – equity raise
- Newcrest Mining (resources) – equity raise
- NextDC (IT) – equity raise
- Many regional banks (financials) – dividend cuts
- Harvey Norman (retail) – dividend cuts
I believe it is important to be active and selective when investing in credit and the current environment is providing a unique opportunity to build a highly tailored and resilient core portfolio. Investors now have the benefit of a very healthy pipeline of primary market investment grade issuance, AUD strength/USD weakness not seen since 2018, and the benefit of portfolio construction (credit quality, duration, currency, sector section? etc) in light of the challenges posed by COVID-19 in the short to medium term.
If you are considering a direct bond portfolio, a positive first step is to open an account (with no cost or obligation) and start receiving high quality primary market (IPO) offers. For some more detail please see New issues remain attractive from our previous edition of The Wire.