Fixed Income: US Election positioning
Prior to the US elections and similar to consensus, we also anticipated a Hillary Clinton victory in the US presidential elections. However, we were of the view that some parts of the market had potentially overestimated the certainty of Clinton winning the election, which warranted a cautious approach.
As it became clear that Donald Trump would be voted in as the next president of the United States, global markets reacted as expected with a broad – yet relatively muted - risk-off move across asset classes. Within the fixed income market, this was demonstrated by an initial rally in Treasuries, steepening of the yield curve, wider breakeven levels, general spread widening and a modest sell-off in the emerging markets.
Though still very early days, the market reaction – unlike Brexit - has been relatively muted, after the initial knee-jerk sell off. While the initial risk-off trade was understandable, the fixed income market appears to be placing increased emphasis on Trump’s plans to boost public spending and reduce corporation tax rather than some of the more extreme parts of his political agenda. Treasury markets reversed course on the day Trump’s victory was confirmed, with yields ending higher on expectations that fiscal stimulus will feed through to higher inflation.
The tone of his speech on November 9th was certainly more conciliatory than those he gave during the campaign and may suggest that he understands the need to ‘tone-down’ some of the more aggressive policies of his in order to appease those in Congress.
As we look across the fixed income spectrum, this is not the time to make big directional calls given the likelihood of short-term volatility and nervousness among market participants. We are not looking to make any significant changes immediately on the back of the result. We appreciate there will be movements within sectors as investors digest this, but we await more clarity on Trump’s exact policies before assessing their potential impact on our portfolios.
Credit spreads widened post the election result, and we expect a period of much higher spread volatility. The Trump win and Republican sweep could lead to substantial changes to the Affordable Care Act (Obamacare), which could negatively impact healthcare service companies. However, pharmaceutical companies may benefit longer-term from a reduced focus on drug price increases. The potential for less stringent environmental regulations may lead to higher domestic oil and gas production with the potential for more drilling on federal lands. Looser regulation could also boost the use of coal for electrical generation.
North American steel producers stand to benefit from any tariffs placed on foreign steel imports and the expected increase in infrastructure spending in the US. Meanwhile, potential modifications to the Dodd-Frank legislation may result in lighter regulations on banks. While this could potentially increase returns on equity, it could come at the expense of creditworthiness as the current regulatory regime requires strict limits on bank leverage and capital requirements.
Global Investment Grade
The portfolio was cautiously positioned heading into the election, with a neutral view on US risk and an overweight to Euro risk given what we believe are more attractive risk-adjusted returns in the region. Overall, the portfolio has a short duration; and we have put in place hedges against rising rates and rising rate volatility, which could lead to a credit sell-off. Prior to the election, and specifically to protect against any adverse reaction to a Trump victory, the portfolio utilized option strategies such as payer spreads to be short credit risk and long volatility. The portfolio also has a small long US Treasuries versus Bunds to cover some of the short duration position against a flight to quality move on a Trump win.
By sector, we are overweight banks due to higher yields and steeper curves, which will alleviate pressure on the sector. We are underweight oil and gas and also have a small underweight to metals and mining, although this position has been reduced. Prior to the election, we also reduced overweight to pharma names, especially those most exposed to pricing issues.
Global High Yield
As at the close of November 8, 2016, we had 76.22% in USD denominated bonds. The portfolio remains cautiously positioned with an underweight to BB credits, which are the most interest rate sensitive bonds, and an overweight to single B names. We remain underweight energy but are making selective investments where we see survivors in the sector. In terms of sector allocation, we have key overweights in consumer cyclical and non-cyclical categories of healthcare, food and beverages, consumer products and leisure.
Emerging Market Debt (EMD)
EMD Hard Currency
We were running the portfolio as close to neutral as possible going into the election, with low beta risk, duration times spread (DTS) flat and cash around 3%.
EM Hard Currency Corporates
We are also running a neutral portfolio with low beta risk; low DTS and an underweight to duration. Cash in the portfolio is relatively high at 6.5%. We prefer to be underweight regions where there is limited spread tightening potential but sizeable risk of large spread widening. As such we have a moderate overweight to regions where spreads provide adequate EM premium; for example Latin America.
EM Local Currency
We ran the portfolio with comparatively low levels of risk going into the election, and low beta exposure. The portfolio is long duration and fairly neutral in terms of sensitivity to the US dollar.
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