Investment Desk Bulletin

16 February 2018

Fixed Income: Financials to Hybrids Core Asset Holdings

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By Sanjay Joshi and Craig Shute

Recent financial market gyrations have been triggered by rising inflation expectations, higher government bond yields and investor wariness of tighter monetary policy. In this week’s IDB we revisit our core fixed income strategies and reflect on how they have weathered recent volatility.

London and Capital’s core allocations in financials, emerging market hard currency and high yield debt have demonstrated a relatively low correlation to the correction in equity markets. Although the combination of tighter monetary policy, faster growth and fears of higher inflation have triggered a backup Government bond yields, our core allocations in FI have remained relatively stable. As the inflation and monetary policy backdrop adjusts, it is likely we will see further episodes of volatility.

The Fixed Income team is always evaluating what we hold as core asset holdings, this week we take an in depth look at Financials and Corporate Hybrids.

Since the 2007 crisis, regulators and politicians have transformed the banking system by increasing capital buffers and tightening the regulatory straight jacket. This trend is expected to continue in coming years with banks moving towards a well-defined capital structure, higher countercyclical buffers and subject to ongoing stress tests. The low or negative correlation of these instruments to government bond yields, provides a haven against rising government bond yields.

As a result financials will remain a core allocation within a diversified portfolio and London & Capital, while remaining abreast of the risks associated with financials exposure.

The corporate hybrid market has become increasingly diversified over the last decade both in terms of companies participating in the market and the investor base. What makes corporate hybrids attractive to investors is that they are typically large, well-run, public-listed companies, operating in highly regulated sectors with a high degree of transparency, yet a higher yield can be picked up by accessing lower parts of the capital structure. Corporate hybrids are a favoured core holding due to the limited near-term financing requirements of these corporates, investor value and availability of investment grade and high yield issues.

Finally, selective high yield continues to provide opportunities for portfolios given the firm economic backdrop, ongoing balance sheet deleveraging, potential for further spread compression and low default rates.