The low yields in the bond market have made it relatively uninteresting to the average investor, but there is a revolution underway. The bond market has been dominated by traditional techniques and old school investors, but many of the quants and hedge funds that overturned the equity market are eyeing the bond market. Systematic corporate bond investing is expanding and firms are taking advantage of trends in government debt or pricing anomalies in bond derivatives. Driving this trend in the bond market is swaths of data that are a part of how trades are now realized. Companies like Blackstone Credit are prepared for the shift into a more systematic trading environment in bonds, and other companies are ramping up their tools to accommodate this shift. FINSUM: Hard to acquire data, and a less liquid market have made bonds less desirable for quants, but the information age is rapidly changing that standard.
The bond market boon has been bad for many fixed income investors, and debt is coming to term in a higher inflationary environment which is eating up all the return. However, bond market investors are turning to factor based investing to earn excess returns. Factor investing is a $700 billion market in equities, and it dwarfs the $25 billion dollar fixed income factor market. Factor investor modifies indices based on factors they think can give an edge over traditional indices. Active bond factor investing can outperform traditional indices in rising yield environments, but factor investing is looking to rival these active funds with systemic decisions. A ‘smart beta’ approach will look to outperform in high yield and emerging market debt.
FINSUM: The extensive literature on systemic fixed income is relatively small, and that's why smart beta strategies have failed to take off in the bond market like they have in equities.
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Dalio is quick to remind everyone to avoid holding cash as inflation eats away at holdings, but he also recently provided stocks for investors looking to hedge. The first on the list is Global Payments which has sound fundamentals and sequential quarterly revenue gains and is a bright spot in a growing industry. The next was Levi Strauss and Company which shrugged off naysayers who believed supply constraints and bottlenecks would keep them from meeting demand. Finally, was Lithia Motors which is a large automotive group. Supply constraints have boosted used car prices and the industry’s bottom lines.
FINSUM: These are all unique picks that have their built in inflation benefits, particularly the automotive industry.
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Evergrande’s crisis has been all over the news in the last month, but it appears there is contagion in the high yield debt market. The bond market sell off, particularly from off-shore investors has spread to companies like Tencent and financial companies like Bank of Communication Hong Kong. This has pushed the ICE BofA Asian Dollar High Yield Corporate China Issuers Index to over 25%, which is the peak yield for the index since 2008. Sparking the yield climb is a combination of regulation, high leverage, and low liquidity. A bump in liquidity from the Chinese central bank has calmed domestic investors, but ultimately government policy will have to lighten up for yields to start to fall.
FINSUM: The endless regulation is spilling into the rest of the economy in China, and no amount of liquidity provisions will bring back outside investors. Rather, China needs to loosen the grip if they want to give companies a chance at refinancing their debt moving forward.
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Strategists for Goldman Sachs, Christian Mueller Glissmann and Peter Openhiemer, say that government bonds are failing to meet the traditional hedging requirements and to consider higher cash and equity allocations. There is still a small negative equity/bond correlation and investors shouldn’t leave the traditional 60/40 split immediately. There are other reasons to allocate more to equity though such as a higher equity risk premia. Inflation is eating away very low yields, making cash a better relative investment, and rate volatility could be even higher in the upcoming Fed cycle. If bonds/equity correlation moves to zero then a balanced portfolio is futile and cash is the safer option.
FINSUM: Investors should need to watch the real return on their fixed income investments and high yield debt might not be worth the risk to generate the ‘normal’ bond returns.
China has banked an inordinate amount of U.S. dollars in the last couple of months as trade surpluses and inflows flow into its bond market. The Chinese trade surplus through September was about $100 billion larger than its 5 year average preceding the pandemic. This current account will provide a buffer against any foreign debt problems regardless of any economic situations China faces this year. The current account surplus could allow China to deleverage its corporate debt market, particularly in real estate, which has faced a difficult bond market. China’s dollar holdings have allowed the yuan to appreciate like other emerging market currencies, such as in Russia and Columbia. Holding greenbacks is a bet on a growing U.S. Economy, and could help China hedge their slower growth.
FINSUM: The large current surplus could mean myriad things for China, but it could also just be another symptom of the global economic disruption due to Covid-19.