Traders work on the floor at the New York Stock Exchange, March 2, 2020.
Brendan McDermid | Reuters
LONDON — A “great rebalancing” of investor portfolios away from core government bonds and a “coupon clipping environment” for markets are coming into view in the fourth quarter, according to HSBC Global Asset Management.
In its quarterly outlook report, HSBC characterizes the global economy as entering the second, flatter, phase of a two-stage “swoosh-shaped” recovery in which growth is set to moderate.
Mobility data indicates that the speed of recovery slowed in the third quarter and the previous strength in consumer spending is also starting to slow, Global Chief Strategist Joseph Little highlighted in the report published Friday, adding that any further recovery is more reliant on services sector spending, which remains compromised by social-distancing measures.
“Meanwhile, Covid-19 is still with us, unemployment rates are abnormally high, and savings ratios are elevated. All of these factors tell us that we face a prolonged phase of low output ahead,” Little said.
HSBC’s working assumption is that the economy will be operating at 90-95% of pre-Covid-19 levels over the next six to 12 months, and Little said the market needs to adapt to this new reality.
“We think it implies a new, range-bound scenario and, for investors, a focus on carry and income — which we describe as a coupon clipping environment,” he said. A coupon usually refers to the annual interest rate paid on a bond, with “coupon clipping” referring to investors collecting these interest payments as the bond matures.
“Going forward, investors need to be realistic about the investment returns that are achievable from here,” Little said.
The greatest downside risk to these assumptions, Little anticipates, is the outlook for policy support. Governments and central banks have already deployed historically large quantities of fiscal and monetary stimulus in a bid to shore up their economies from the long-term effects of the pandemic.
“While significant fiscal space remains due to low inflation and low bond yields, it seems increasingly likely that fiscal support in developed markets will be withdrawn prematurely, due to a combination of stimulus fatigue, conventional thinking about the deficit and political gridlock,” Little suggested.
He added that this risk will vary from country to country, with the U.S. in an advantageous position having already made some progress toward its second fiscal package.
The ‘great rebalancing’
Offering positive returns and negative correlations to equities, government bonds have been one of the most useful asset classes to own over the past decade, but Little suggested that low yields and a shift in macroeconomic policy beyond interest rates should bring about a “great rebalancing” of investor portfolios away from core sovereign debt.
Within traditional asset classes, he said portfolio resilience could be built by diversifying into inflation-linked bonds and some commodities, like gold.
“Alternative strategies, which have progressively been taking up a larger proportion of institutional strategic allocations, are another attractive option,” Little said.
“Although returns of strategies that offer low beta to equities, low duration, and moderate volatility have been low in recent years, poor prospective returns on government bonds favour the increase of the allocation to liquid alternatives.”
Beta is the measure of volatility or systematic risk associated with a particular security or portfolio.
Current macroeconomic headwinds and an environment of persistently low returns could offer long-term investors an entry point into illiquid alternatives such private equity and venture capital, Little suggested. In particular, he highlighted opportunities in funds exposed to “Asia growth and technologic dynamism. “
“Meanwhile, investors willing to exchange portfolio liquidity for income can benefit from investments in securitised debt and infrastructure where valuations are attractive,” he added.
