Defensive Diversifiers: Seeking Low Risk Yields
Expected returns on good quality bonds are low. So investors will most likely move to other asset classes while limiting risk.
• Diversification reduces the overall risk of the portfolio. Our recommendation: certain low-risk products or ones with a calculated risk like Investment Grade corporate bonds, alternative funds, and structured products.
• Such solutions benefit from the more volatile environment and the greater differences in the quality of companies.
Opportunities in the fixed-income universe
The health care crisis and subsequent market corrections are creating new opportunities in fixed income markets:
- Yield spreads have widened sharply on quality corporate debt and on subordinated financial debt.
- The banking sector is well capitalised, especially in Europe.
- The default rate among Investment Grade issuers is low.
Risks lie in the potential deferral or non-payment of the coupon, and no redemption at the first call date.
Green bonds issued by US companies also merit attention. There is a good supply and yields are attractive. They behave like traditional bonds, the difference being that they finance projects primarily aimed at mitigating climate change.
Finally, Emerging Market bonds in local currency also have certain advantages.
Valuations are low and Emerging Market currencies are undervalued, assuming that central banks in developed countries will remain accommodative. Emerging Market bonds in local currency are also a good diversification tool in portfolios. Leveraged loans in Europe offer both an attractive risk/return profile and a natural protection against the risk of rising interest rates since the income generated is based on variable interest rates. This type of asset is not suitable for all risk profiles. Liquidity can be low, so we recommend investing over a long period.
Alternative strategies have suffered in the general risk aversion environment but once again demonstrated their diversification properties. Asset managers in this area can benefit from the increase (or decrease) in asset prices.
We favour ‘Macro’ and ‘Long-Short Equity’ strategies as the Covid-19 shock, trade tensions and populism are putting pressure on certain sectors, and generating volatility and therefore opportunities. 'Event-Driven' strategies also offer attractive prospects given the expected growth in non-performing loans and devalued assets.
The sharp increase in volatility since the beginning of the pandemic offers a more favourable environment for structuring products selling volatility with attractive asymmetric payoffs. These products quite frequently have partial capital protection. They are structured on very different underlyings, with varying degrees of complexity, from a simple stock market index to term contracts, options or interest rate spreads.
Structured products are portfolio diversification tools that can improve risk/return.
• A broad diversification, short-term bonds and a choice of high-quality issuers can mitigate these risks.