Volatility in high yield and short-dated credit markets has been lower than for government bond markets. Donald Phillips explains why and how the current low growth and stable economic environment can be positive for credit markets.
If we step back and look at the economic data released so far this year and in recent weeks and months, a fairly consistent picture is emerging across most developed markets. In the US, since the economy reopened after the government shut down, growth has been holding up reasonably well, people have been remaining in jobs. Inflation has been a bit stickier than policymakers would like in terms of the 2% target, but it's not what we would call problematic either. Taken together, that's led markets to question whether many more interest rate cuts are actually needed or whether enough easing has already taken place over recent months. The UK tells a similarish story, although growth here looks more anaemic than in the US. Meanwhile in Europe it has been fairly subdued on the growth front but inflation has also behaved in a relatively benign way. Now at first glance, a low or no growth environment doesn't sound especially exciting, but if employment remains broadly stable, and so far it has, this is a constructive backdrop for credit markets. The reason for that is very simple. Corporate investment decisions like capital expenditure are largely discretionary. Companies can slow capital spending if conditions become uncertain, but interest rate payments are not discretionary. As long as defaults don't rise meaningfully, the yield you earn from credit, particularly high yield, tends to be a very good predictor of medium-term returns. Today, that yield is around 6.5%, which is compelling in a historical context, and I think stacks up well versus many, many different asset classes. Importantly, the data most relevant to credit markets that we invest in has remained supportive. The dramatic market moves recently haven't really come from macro and company fundamentals. Instead, they've come from external, political, and policy-driven forces which have had a much bigger impact on global government bond markets. In fact, areas like high yield and certainly short-dated credit, have felt like something of a safe haven compared to the traditional safe havens such as government bonds. For example in the US, we've seen political pressure being piled onto the Federal Reserve, including threats of criminal action against Fed Chair Jerome Powell. That undermines confidence in central bank independence and has been particularly uncomfortable for longer-dated US Treasuries. We've also seen renewed tariff threats, which are inflationary by nature, and risk reinforcing a broader 'sell-America' narrative, pushing US bond yields higher still.
Perhaps the most striking recent moves, though, have been in Japan. Growing concerns about fiscal sustainability, an issue shared by many developed economies, have triggered a sharp sell-off in long-dated, particularly long-dated Japanese government bonds. This has also raised questions about the so-called yen carry trade, where Japanese investors, historically large buyers of overseas assets, may now be repatriating capital as domestic yields rise. The result has been higher global bond yields and steeper yield curves. In that environment you would of course expect short-dated investment grade to be resilient, and it has been, but high yield not completely immune to these forces but it has continued to show a high degree of resilience helped by relatively low sensitivity to interest rates and confidence in companies' ability to their debt. In short, while government bond markets have been volatile, credit has continued to do what it's meant to do, provide income stability and a degree of insulation from the more disruptive forces driving global markets today.
KEY RISKS
Past performance does not predict future returns. You may get back less than you originally invested.
We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments.
The single strategy funds managed by the Multi-Asset team:
- May consider environmental, social and governance ("ESG") characteristics of issuers when selecting investments for the Funds.
- May hold overseas investments that may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of a Fund.
- Holds Bonds. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay.
- May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.
- May, under certain circumstances, invest in derivatives, but it is not intended that their use will materially affect volatility. Derivatives are used to protect against currencies, credit and interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The use of derivatives may create leverage or gearing resulting in potentially greater volatility or fluctuations in the net asset value of the Fund. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. The use of derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash.
- May invest in emerging markets which carries a higher risk than investment in more developed countries. This may result in higher volatility and larger drops in the value of the funds over the short term.
- May target an absolute return. There is no guarantee that an absolute return will be generated over the time period stated in the fund objective or any other time period.
The risks detailed above are reflective of the full range of single strategy funds managed by the Multi-Asset team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
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Donald Phillips
Donald Phillips is head of credit in the Liontrust Multi-Asset team. He joined Liontrust in February 2018 from Baillie Gifford. Previously, Donald had been co-managing the European high-yield strategy at Baillie Gifford since 2010.
