Society has the most to benefit from a higher emitter moving towards lower emissions rather than buying a wind farm credit that might add one or two more wind farms to its
portfolio. Scott Freedman, Newton Investment Management
good environment for high yield, given the growth backdrop. But there are concerns around the cycle and inflation and what they do to the fundamentals. We will see increasing volatility this year. One area driving that is the authorities’ response to Covid and the levels of stimulus that came into the markets. We were late in the cycle when Covid hit, but the period to close the output gap the stimulus created was quite short. So, we approach the end of the busi- ness cycle faster this time because the cycle has been compressed. Company fundamentals have been strong, but to what extent will they be impacted by higher costs? Also, are some areas of the market vulnerable to slower growth? It is about being nim- ble within fixed income in a more volatile environment as yields continue to rise.
We are speaking on the eve of what could be an invasion of Ukraine. What impact is this having on the bond markets? Nash: The fundamentals win out in the end. We are still in stalemate and waiting to see what happens. The bond markets sold off quickly, but there was not much of a rally at the front end. That says inflation is a big problem. It has surprised to the upside into this year and growth is good and well rounded. You have to hold your nerve. Look at the price action and you can tell the fundamentals are pointing to high yields.
Our fund’s volatility is similar to that in a bond fund, but in a bear market it is easy for us to outperform and we have made a positive return so far this year.
What are your clients discussing when it comes to fixed income, Colin?
Colin Reedie: We have a variety of institutional clients on various stages of the journey towards end-game. There are those seek- ing yield and those taking a cashflow-matching approach. We are servicing those needs, but the number one topic is the back-up in yields and how persistent is it going to be.
2021 was not a great time for fixed income. Are there better times ahead? Scott Freedman: The first quarter of 2021 was interest rate driven, but there were periods through the year when it was a
What will happen to the inflationary picture? Reedie: The market is going from a “don’t worry, it will be tran- sitory” narrative to “we might have a stickier problem”. I sense we are looking to price how persistent it is going to be. Head- line inflation has probably peaked. As we re-open and supply chains normalise, the eye-popping numbers will tail off. That is largely in the price. Everyone has their models and can see it coming down, but what will be revealing is if wages con- tinue to rise. Markets will focus on it because central banks will have to remain hawkish. History suggests that behaviours do not change after a major upheaval, but something is happening in the labour market. People are taking lifestyle decisions in keeping themselves out of the labour force for longer to enjoy life more or are changing not just jobs, but industries. This is radical stuff. This is leading to a shortage of working-age labour. If this con- tinues, it will be difficult to see it not manifesting itself in broad-based wage growth, which means this is a longer-term issue.
Celene Lee: Asset owners worry about rate rises and bonds los- ing money, but defined benefit funding levels are as high as they have ever been.
That is a critical point as, unlike five to 10 years ago, many schemes are well funded and often close to fully hedged on
April 2022 portfolio institutional roundtable: Fixed Income 9
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