Lessons from Japan
Recent events accentuate the global debt problem and reaffirm our “lower for longer” thesis. In order for this level of public sector spending to be sustainable and/or for governments to remain solvent, yields will have to remain low, just as they have in Japan for decades. Central bank balance sheets will remain elevated to help cap yields and should the bond vigilantes try to push yields higher we could even see yield curve controls introduced, just as they were in Japan.
We can take some lessons from Japan as we continue down the low-growth, low-yielding and low-inflationary path. In Japan, high-quality and non-cyclical companies have done well relative to their cyclical peers and relative to equities. Over the last 20-years, high-quality bonds issued by Japanese utilities companies have outperformed their financials counterparts and the Nikkei 225.
Tentative signs from today’s sterling new issue market suggest this will be a high-quality and non-cyclical rally too. New issues have come with big discounts and non-cyclical credits have tightened more so than their cyclical peers. It seems bond investors are looking through to state of the economy after this immediate health crisis ends, and it is not a rosy picture.
High quality corporate bonds sit in a good spot but active management is key
When considering the reset theme, the central bank and government support for high quality corporate bonds, the history of high-quality corporate bond returns in Japan, the level of uncertainty still out there and the risk-return characteristics of corporate bonds, we feel the asset class sits in a very good place. Governments leaning on corporates to cut dividends are positive moves for creditors. Indeed, it makes the income argument more attractive for fixed income.
That said, there are big challenges for corporate bond investors as we move through to recession with all the associated outcomes from this; migrations across the ratings spectrum and a pick-up in defaults. Monetary and fiscal support are no substitute for intense scrutiny of corporate balances sheets and liquidity. A large research function will be paramount to navigating this challenging period ahead. This is absolutely the time when active management has to step-up.
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Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and current and semi-annual reports, free of charge on request, by calling 0800 368 1732. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0420/30140/SSO/NA
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