Name: Currency volatility and hedging choices
Start: 2023-03-03T14:20:00Z
End: 2023-03-03T14:31:24.000Z
Location: BrightTALK
Rating: 0

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Insight's quarterly Euro LDI review and outlook | May 2023

Insight special topic webinar: Global credit

Insight's quarterly fixed income review and outlook | April 2023

Insight's quarterly multi-asset review and outlook | April 2023

Senior Market Strategist, David Jamieson, will provide an update on interest rates, inflation and other recent market developments affecting LDI.

Insight’s quarterly LDI review and outlook | April 2023

We believe there is now a relative value opportunity in asset backed securities as:
Arrears levels continue to remain benign; average loan-to-values are lower than before the GFC; underwriting is better than before the GFC.
Spreads are currently wide which does not promote strong issuance which gives the asset class a tail wind.
There is a significant premium over corporate bonds.

What are low spreads in ABS telling us?

Insight is increasingly helping clients meet tailored responsible investment objectives, in particular for Paris alignment of portfolios.
Provision of carbon footprint reporting by bond issuers is improving; we expect it to reach 90% of most portfolios over time.
Forward looking metrics are essential for investors in meeting credible carbon reduction targets.
Our projection of sterling based corporate bond issuers is that most are not currently aligned or prepared to align for net zero by 2050.

How we help clients meet RI objectives

Municipal bonds are high quality instruments designed to finance US infrastructure.
Municipal bonds finance transportation, social infrastructure, public utilities and energy.
The default rates for investment grade municipal bonds from 1970 to 2020 is 0.09% compared to 2.17% for investment grade global corporates[1]
So, for investors seeking both yield and safety they maybe an appropriate investment.
Municipal bonds are designed to fund infrastructure that provides a positive impact for local communities.
[1] Source: Moody's cumulative default rates by rating category. 1970-2020

An introduction to municipal bonds

Although inflation has likely peaked in the short term, we believe the era of stubbornly low inflation that has characterised recent decades has come to an end.
With inflation peaking, markets have shifted to price in rate cuts later in 2023 – we would disagree with this view.
The inversion in most yield curves leaves us cautious on longer-maturity issues until there is greater reason to expect meaningful rate cuts.
Market volatility is likely to remain high, bringing more dislocations but also potentially opportunities, especially for active investors.

The investment landscape for 2023

2022 was a dramatic year for liability driven investment, with real yields reversing 15 years of declines within a nine-month period.
There is a material amount of gilt issuance expected in the years ahead and, once pension demand for gilts is eventually sated, yields are likely to structurally shift upwards.
The traditional balance within LDI portfolios has been disrupted, but we believe there are various things that clients can do to restore this balance.
Solution resilience and collateral efficiency are two key aspects that need to be considered when building LDI strategies.

LDI – Lessons for the road ahead

Impact investing targets positive, measurable social and environmental impact over a longer-term investment horizon.
Although impact markets have been dominated by green bond issuance, this is changing and there has been a rapid growth in broader social bond issuance over the past five years.
Even within green bond markets, the number of sectors issuing has broadened considerably, allowing greater diversification and more targeted investment.
Greenwashing is a real problem – Insight assesses impact bonds for their likelihood of achieving the social or environmental good they offer and we gave only 26% a top rating in 2022.
Impact investment offers greater transparency in terms of how proceeds are used, and issuers often provide performance updates which allow investors to understand the impact being made.

Assessing impact bonds

We favour a global approach to credit investment as it maximises liquidity, opportunity and diversification, and allows dislocations between markets to be exploited.
Currently, European credit offers value relative to the US, but for those that do not want to take European economic risk this opportunity can be accessed via overseas issuers in European currencies.
To maximise liquidity, it’s important to be able to access a broad range of instruments, from direct holdings to credit default swaps, exchange traded funds and total return swaps.

Finding relative value in global credit

Yields on US high yield bonds rose markedly in 2022. By the end of the year, the average yield for US high yield debt stood at 8.7% of which 4.2% was attributable to rates and 4.5% attributable to spreads. For Fallen Angel bonds (those that have dropped out of the investment grade universe and into high yield) the spread is 3.8% as at the end of December.
Our research indicates that the average fallen angel bond declines around 10% in value over the six months prior to its downgrade. The research also indicates that in the subsequent 12 months after downgrade it grows around 20% in value.
The Fallen Angels universe consists of roughly 100 issuers and 300 bonds.
There were no defaults in the Fallen Angels universe in 2021 and 2022.

What is the default risk for high yield debt?

With quantitative easing drawing to a close, high yield credit once again offers a ‘high yield’ and we believe spreads now more than compensate for default risk.
Fundamentals within US high yield are unusually strong, with issuers having extended maturities and reduced debts, leaving them with considerable buffers to withstand any economic downturn.
Historically, investors have generally had a hard time achieving the full return premium available in high yield credit markets, as liquidity constraints and high spreads have eaten into returns.
Insight's efficient beta strategy is an efficient, systematic process designed to capture broad exposures in a risk-controlled and cost-effective way, allowing investors to more fully capture potential returns.

Cutting high yield trading costs

The fundamental backdrop for credit markets is mixed, with tighter monetary conditions slowing economic growth and inflation and real borrowing costs still elevated.
Global investment grade credit spreads have cheapened, but valuations are not that exciting given the fundamental backdrop.
We foresee above average levels of volatility and market dislocation in the short to medium term, potentially leading to opportunities for active managers.
For those with a broad remit, some segments of credit markets appear attractive, including high yield, asset backed securities and US municipal bonds.

Current credit fundamentals

2022 highlighted the vulnerabilities of a static asset allocation as both bonds and equities lost value during high volatility.
Another potential risk for asset allocations is the large rise in the US dollar. We foresee some element of mean reversion in the dollar and this could cut gains investors have made from the appreciation in the dollar if such currency risk is not managed.

We believe asset owners can gain greater control over their investment journey if adjustments are made to their strategic asset allocation on a tactical basis, new sources of return and from an active approach to currency exposure.

Bespoke asset allocation overlays

Insight’s Euro LDI review and outlook

After a 15-year rally in the value of the US dollar, many non-US investors have experienced significant currency gains on their US assets.
Over the medium term, there is a risk that this trend will reverse, making this a good point to review currency hedging policies to lock in these gains.
A dynamic hedging programme has several advantages over a static hedging programme and should be cashflow generative over the medium term, relieving pressure on collateral pools.
For pension funds, a sharp reversal in the US dollar could result in a meaningful deterioration in funding if assets are left unhedged.

Currency volatility and hedging choices

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Currency volatility and hedging choices

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