In a risky environment of rising interest rates and continually underperforming growth stocks, investors would typically flock to traditional “safe haven” asset classes such as fixed income assets.
However, with geopolitical pressures coupled with the US Federal Reserve’s (Fed) reaction to high inflation, fixed income assets may not have behaved like the classic safe havens that investors expect, says Manulife Investment Management (Manulife IM) multi-asset client portfolio manager Paul Kalogirou.
Says Kalogirou: “We are at a point now where we have had this significant drawdown in risk assets and we have had a Fed reaction to that. And the market, to some degree, has anchored itself around where they think the Fed is going to go in terms of rates at around 3.5%. The Fed is sort of going full-blown into pushing up to that level. They’re not looking to finesse or provide any soft rhetoric to the market.
“Clearly, they need to strong-arm inflation lower. Not only is inflation detrimental to different asset classes, there’s also a political element as we head into the November Biden midterms. Biden is putting pressure on Powell to get hold of inflation as that is the concern for the voter base, rather than impact to growth.”
On July 27, the Fed raised its benchmark policy rate by 75 bps for the second month in a row, in its effort to tame soaring inflation. This takes the benchmark overnight borrowing rate up to a range of 2.25%–2.5%.
In this market cycle, investors can leverage global multi-asset diversified income strategies of traditional and non-traditional income sources to harvest income, says Kalogirou. With a multi-asset strategy, investors can gain access to a wider range of income-generating assets as well as greater depth and diversification within asset classes.
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“Income investing is something that we see as attractive in this environment, allowing investors to capture higher income from rising rates. Additionally, having traditional and non-traditional income sources across a diversified global asset base allows them to achieve reasonable mid to high single-digit income returns,” says Kalogirou.
These non-traditional income sources include high-yielding REITs, preferred securities and option writing strategies. While investors may not be very familiar with some of these assets, they are beneficial in adding diversification of non-traditional income sources to one’s portfolio as they provide relatively higher yields compared to traditional asset classes, while having moderately low correlation.
Option strategies, for instance, can potentially increase the overall yield of an investor’s portfolio, as well as provide a downside buffer during periods of a market downturn, says Kalogirou.
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“At the end of the day, everything depends on the different outcomes that investors want. If they want a return-type profile, then higher-quality investment grade-type bonds and add duration into this area. If they are looking at income, then for sure they need to be in that high-yield bucket, option writing, REITs, preferred securities and even high-dividend stocks.”
Unfavourable assets
Among the different assets, Kalogirou notes that China credit has had a “pretty challenging time”. Numerous property companies face mounting debt problems to the point that several distressed events have happened, further weighing down on the market’s sentiment. The growing list of defaulters includes Shimao Group Holdings which failed to pay off a US$1 billion ($1.4 billion) offshore bond that came due in early July. United Overseas Bank, one of its creditors, is reportedly suing Shimao.
“With the distress, I think investors would probably not start banging on the table and thinking that these are great areas to be deploying capital. However, there could easily be some policy responses from China that could start to support parts of the market. At the moment, our Asia credit team thinks that the policy response is not as adequate to support the sector.
“While there are investors holding this asset class who remain hopeful in seeing recovery, we may not be deploying new money into Asia credit, from a global income multi-asset portfolio strategy perspective,” says Kalogirou.
From his perspective, if investors want to put in money, they ought to watch out for several inflexion points, especially positive policy responses to the beaten-up property sector, as well as signs of recovery from the ongoing Covid-19 pandemic, which has been one of the key drags on the Chinese economy. He points out that in the month of June, China equity and parts of credit both outperformed, which is largely a function of news flows suggesting that “the worst is over”. However, in July, certain cities continue to face what is seemingly a never-ending loop of zero-Covid policy.
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Meanwhile, demands for certain basic metals have been hampered due to the growth slowdown among various global economies. The metals which include nickel, copper ore, iron ore and aluminium have all experienced a challenging environment in recent months. The S&P GSCI Industrial Metals which serves as a benchmark for investment in the commodity markets, for example, is down more than 15% ytd as at July 28.
That being said, investors should not discriminate against the whole commodity space, says Kalogirou. “There are pockets that are doing reasonably better, but there are also pockets that are not doing too well — materials would be an area of caution. This is a function of global demand and the market now readjusting to slower growth, or at least expecting slower growth and GDP downgrades that we’re starting to see,” he adds.
Adding risk
Manulife IM has a few multi-asset strategies, one being the Manulife Global Fund — Global Multi-Asset Diversified Income Fund. As at June 30, the fund’s asset allocation consists of equity-related securities (25.19%), developed market equities (21.19%), high yield bonds (24.2%), emerging markets (13.49%), preferred securities (4.29%), investment-grade bonds (3.25%), as well as cash and cash equivalents (8.39%). In 2021, the fund provided calendar year returns of 12.23%.
Kalogirou says that versus its peers, Manulife IM’s multi-asset diversified income strategy had a superior drawdown capture profile. “The income approach that we have at Manulife is a pure income approach, which means that we are not necessarily relying on capital gains from equities or fixed income to pay out the returns to the clients.
“What we are looking at is generating a natural income from the coupons and option premiums, which are pretty high at around 70% of the payout. We do not have to rely on a continuation of outperformance of growth assets or spread tightening in credits. In many ways, this has helped us to buffer some of the drawdowns in terms of the overall portfolio composition.”
He adds that there are already discussions on whether the firm would increase its allocation in risk assets moving forward. However, Kalogirou says it is unlikely to happen anytime soon given the prudence and conservatism of Manulife IM as an insurance-related firm.
“Over the past five months, the focus was more on risk management and using futures to manage volatility as well as duration risk. Today, those elements still exist, but we are starting to talk about adding risk. We think that the next six to 18 months is a reasonable timeframe for the portfolio managers to keep in mind to add certain securities into the portfolio.”
