Despite significant rises in bond yields, Newton Investment Management’s Paul Flood is preferring to look to alternative assets as a source of future income within his BNY Mellon Multi-Asset Income fund.
With US 10-year government bonds now yielding more than they have at any time over the past decade, Flood noted that returns for bond investors are rising, at least in nominal terms.
However, with inflation remaining above expectations, and recent US CPI reading of 8.6%, he argued real returns remain unattractive and central banks are still under pressure to raise the pace of interest rates increases
“This is resulting in bond market weakness and a knock-on effect to equity markets as investors remain concerned that policy measures result in pushing the economy into recession, which could result in inflation coming back down to the central bank target,” he said.
Important role
While Flood has begun to increase the fund’s exposure to US treasuries, he said in general as bonds lose their lustre, alternative assets such as renewable energy, asset financing and music streaming are playing an increasing important role in multi-asset strategies.
In terms of renewables, Flood said battery storage companies that help with the transition to renewable power have seen strong upgrades in revenue generation and can gain additional revenues from providing capacity availability to the grid.
“Power prices remain elevated, and we expect long-term power price assumptions will have to rise as Europe tries to reduce its power dependency away from Russia,” he said. “This should benefit many of the renewable companies’ valuations.”
Elsewhere, Flood likes the asset financing sphere where ship and aircraft leasing companies have benefitted from escalating transport costs and a recovery in travel from the pandemic.
“Our holdings in aviation are benefitting as airlines get the Airbus A380s back off the ground and issue positive commentary about continuing to use the aircraft in the long term,” he said.
“These types of assets do not have inflation-linked revenues such as renewables or infrastructure, but in many cases their secondary market values are rising on the back of higher commodities, energy, and labour costs,” he added.
“In addition, companies are considering the overall costs of running older assets longer versus replacing them with new ships or aircraft.”
Music
While the Covid-19 pandemic largely decimated the live music and entertainment scene, Flood said recorded music revenues hit an estimated $12bn (£9.8bn, €11.4bn) in 2020, with streaming accounting for a reported 83%.
“The shift towards a subscription-based streaming model has transformed the economics of the music industry, enhancing the visibility of revenues and allowing for significant margin expansion through lower distribution costs and operating leverage, while gaming, social media, and emerging market growth increase addressable markets,” he said.
Indeed, Flood believes people paying for music via streaming platforms represents a significant growth opportunity, particularly among audiences in emerging markets such as China, India, Africa and South America.
“Another strength of investment in music royalties is that it is relatively uncorrelated with the economic cycle,” he added.
“The near-universal appeal of music and its importance throughout our lives also gives its commercial strength real longevity.”
Bond sentiment
Looking ahead, Flood noted that geopolitical tensions could continue to cast a cloud over financial markets in the short term, with the threat of military escalations creating an uncertain investment backdrop, but also resulting in rising interest rates on the back of higher inflation.
“This suggests a more attractive backdrop for bond investing – at least in nominal terms – but given the current uncertainty around growing levels of inflation, we continue to favour real assets,” he said.
“As ever, we remain focused on our thematic and fundamental stock-selection approach, an approach we believe will serve the strategy well over the longer term,” he added.
For Karsten Bierre, head of fixed income asset allocation in Nordea’s multi-asset team, what is going on with bond yields in 2022 is “truly historic”.
“It was always to be expected there would be increases in interest rates and bond yields due to the world getting back on its feet after the Covid crisis,” he said. “But we have actually seen a 30% drawdown in the long treasury bond index – which is crazy.”
Turn back the clock
In fact, Bierre noted the drawdown we have seen since the yields troughed in 2020 exceeds the losses bond investors experienced in nominal terms back in the 1970s.
“All of us remember the financial crisis, which was an awful period to be invested, but the drawdown for high quality European corporate bonds actually exceeds the drawdown investors faced during the financial crisis,” he said. “There really has not been anywhere to hide.”
Apart from Covid, Bierre said investors have to go back to the years just after the European sovereign debt crisis to obtain the yields being witnessed today.
“This makes me somewhat constructive on fixed income returns going forward,” he said.
“If we do see a more substantial slowdown, we will, of course, see some corporate default pressure, but corporates are doing well in terms of credit fundamentals.”
Not only is net debt relative to profits at the lowest level since the 1970s, Bierre noted savings ratios among both households and corporates are positive, which he said might not be good for future growth but is positive for credit fundamentals.
“It is still a difficult environment and there is a risk yields can go higher – at least temporarily – and risk credit spreads can also rise,” he said.
“As a fixed income investor, you need to be adaptive to the environment and be more flexible in your approach.”
