Giordano Lombardo, the Milan-based group chief investment officer at global asset manager Pioneer Investments, explains why investors should be switching from bonds into equities and shares his outlook on Asian high-yield bonds and the effect Japan’s quantitative easing is having on regional bond markets. Pioneer has €165 billion ($214 billion) of assets under management.
There has been plenty of talk about the Great Rotation. To what extent is this happening?
A combination of central bank intervention and blind buying by fearful investors has led to unprecedented low yields on so-called safe government bonds. Despite this, investors continue to pile into bonds. Before the crisis, flows into equity funds outstripped flows into bond funds. In 2008 to 2009, that pattern began to reverse. Today, cumulative flows into bond funds stand at more than $1 trillion more than flows into equity funds, at the global level. If investors start to question if the yields available on these government bonds are adequate, they may begin, what has been named “the great rotation” out of bonds and back into equities. Key institutional asset owners’ allocations to equities are at record lows for both US and UK pension funds. It is our view that these investors will look for significantly higher returns than they are getting from investing in government bonds. At some point, they will increase their allocation to riskier assets in order to earn these returns, starting the “the great rotation” trend.
Should investors be switching from bonds to equities?
Despite several instability factors, we believe it’s rational to be long risky assets and equities in particular. I recently addressed this topic at our thought leadership “Colloquia Series” forum in Beijing. There are primarily three reasons — the first reason is that liquidity injections from central banks are moving the real rate on core government bonds into negative territory, so if investors want to get some returns, they will have to move into other asset classes such as equities. The second reason is that the cyclical components of the economy are improving. Cyclical indicators suggest that the US economy is expanding. China’s rapid expansion is slowing, but it is still leading global growth. For the euro area, despite the weak economic outlook, it is on the right track on structural reforms. However, being long equity is not just a top-down argument. The third argument is that bottom-up, equities have compelling valuations. Also, equity dividends are outstripping bond yields, especially in Europe. As such, equities should be considered a structural source of investor income as well as potential capital appreciation.
What are you overweight and underweight?
We are overweight equities versus bonds. We believe that growth-sensitive assets or risk assets still provide the best investment opportunity. The case for risk is strengthened by leading central banks’ commitment to retaining overly loose policies to stimulate the economy and protect against recurrent risk scenarios. We are taking a more selective approach, notably for corporate bonds whose risk/reward combination is in our view less optimal than it used to be. In fixed income, emerging market bonds should deserve the right place in investors’ allocations amid signs that most governments continue to pursue sound economic policies, hold large foreign reserves and have avoided excess borrowing. Our regional calls on the equity side tend to favour Europe over the US on cheaper valuations as the top-weighted banking sector remains on watch for its exposure to crisis-hit Economic and Monetary Union government bonds. A large number of European-listed companies are mostly exposed to non-euro economies and tend to track global trends though.
Has Pioneer been increasing its allocation to Asian debt?
Our allocation to Asia has jumped from 12% to 19% over the last year. This is a reflection of better prospects for Asian EM [emerging market] economies, more volume and diversification at issuer level. We are positive on Asia for sovereign EM bonds, which is likely to see more upgrades from credit agencies. Our particular picks are Indonesia and the Philippines. These two countries are on track to getting credit updates on the back of improving fundamentals. We also like Thailand and Malaysia, as the exhibit those qualities through currency appreciation.
We have seen record Asian dollar bond issuance year-to-date. Do you expect appetite for Asian dollar debt to continue?
Asia has seen a dramatic increase in bond issuance this year as the region’s companies tap debt markets in the absence of traditional sources of bank lending and as asset managers shift capital away from Europe’s sluggish economies. Issuers will begin to re-leverage, not only in high yield but also in the investment-grade space, as money’s so cheap and the need for infrastructure investment is so high in Asia. So far we have seen roughly $52 billion worth of debt issued year-to-date out of Asian EM and this is set to continue. Issuance of high yield in general is largely outstripping investment grade. Currently, deals are attracting a high level of interest from Japanese investors following the Bank of Japan’s plans for huge bond purchases. This move will have significant implications for the Global bond market, as these investors will be forced to look for high yielding alternatives that are not linked to the weakening yen.
What is your outlook on Asia high-yield debt?
For more than a year, regional Asian flows are largely anchoring the issuance coming from Asia as investors continue to search for yield. This positive technical backdrop has sustained the successful refinancing of Chinese homebuilders over the last twelve months to levels thought implausible not too long ago. The Japanese quantitative easing program can only be supportive of this technical picture as Japanese investors will also be in the market actively trying to beat zero rates. This backdrop will continue supporting high-yield companies and issues coming to market in the future. We particularly like emerging market corporate high yield as it offers investors diversification from the traditional emerging market and high-yield asset classes. Particularly, Asian high yield provides investors with a quasi-equity allocation option that is firmly anchored in macro themes such as housing, cement, coal and basic industry. This choice did not exist some years ago as most investors tapped Asian potential through equities running the additional forex risk embedded in the domestic currency.
Do you feel that the structures and pricing of recent Chinese high-yield bonds sufficiently compensate investors for the risk they are taking?
The risk/reward is clearly deteriorating from a year ago, but from a relative perspective investors are getting compensated when factoring in the growth differential associated with these credit names. From a structure perspective, these have always been weaker in Asia with bonds issued by remote subsidiaries away from the real assets. This has resulted traditionally in a lower implicit seniority of those creditors compared to onshore creditors who may have a direct claim on the actual assets. Challenges remain in Asia credit as each country has different insolvency regimes, intellectual and property rights, and even environmental and consumer protection. Issuers pay a premium for these deficits but investors could arrive at distorted valuations or misread risk.
