Shifting into neutral in multi-asset portfolios

Shifting into neutral in multi-asset portfolios

07-09-2020 | Monthly outlook

The improving global economy has made bonds less attractive compared to equities, says multi-asset investor Jeroen Blokland.

  • Jeroen Blokland
    Portfolio Manager

Speed read

  • Multi-asset team ends overweights to investment grade and high yield bonds 
  • Massive spread tightening has made bonds less attractive than equities 
  • Risks include failure to develop a Covid-19 vaccine and the US elections 

Robeco’s multi-asset team has been heavily overweight investment grade and high yield bonds after the asset classes benefited from massive central bank stimulus to combat the economic fallout of the Covid-19 crisis.  

Now that spread levels – the difference in yields compared to government bonds – have significantly reduced, the fund is switching to a more neutral stance as it awaits new catalysts for further change. These could include finding a vaccine for the coronavirus, or a negative fallout from the US election race. 

“We turned positive on global high yield and investment grade bonds in late March, after both asset classes had realized negative returns that were worse than those on equities after adjusting for volatility,” says Blokland, head of the multi-asset team.  

“At the height of the market collapse, high yield bond spreads rose to almost 1,200 basis points, pricing in a default rate of more than 20%. However, preventing company defaults and job losses became a key aspect of the close collaboration between central banks and governments. In addition, both the ECB and the Federal Reserve expanded their bond-buying universe, benefiting investment grade bonds as well as riskier high yield bonds.” 

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Spread levels between high yield and investment grade bonds have reduced massively. Source: Bloomberg.

What a difference five months makes

“Five months later, things look radically different. The strong cooperation between central banks and governments has become mainstream, pushing bond spreads to levels that are not far from those seen before the global Covid-19 outbreak.” 

“This is at a time in which economic uncertainty remains exceptionally large. Bond yields, already low before the recession hit, have become even more suppressed, leading to a noticeable rise in bond duration.”  

“This is especially the case for US investment grade credit, for which the average duration has increased by a full year since the March lows, to 8.7 years at the end of August. With spreads contracting by a full 250 basis points to 130 basis points, investment grade bonds are now much more exposed to duration risk, which is not something we necessarily like.” 

The allure of equities is increasing

Blokland says that this means the allure of equities relative to bonds has increased. “To be clear, on a standalone basis, equities do not look cheap, and in the case of the US they are outrightly expensive,” he says. “But within a multi-asset portfolio, it’s relative valuation that counts.”  

“Also, recent economic developments suit equities well. While we continue to believe that a V-shaped recovery of the overall economy will be difficult to achieve, developments in some parts of the economy do fit that definition. Retail sales, for example, are already above the levels reached before the global virus outbreak in many countries, including the US.”  

US retail sales have recovered to above pre-Covid-19 levels. Source: US Census Bureau.

Earnings outlook is improved

The outlook for company earnings also looks a bit brighter, he says. “First, second-quarter earnings data was much better than expected, with US companies beating expectations by the largest margin on record. Hence, the base from which earnings have to recover is markedly better than previously estimated.”  

“Second, we should not underestimate the impact of operational leverage. The flipside of the slower labor market recovery, where there is no such thing as a V-shaped recovery, is that companies focus on productivity growth and lower costs in their recovery.” 

“So, while it is debatable that headline sales numbers will be back to pre-Covid-19 levels next year, operational leverage helps bottom-line earnings per share numbers to recover more quickly. This seems somewhat overlooked by investors these days.” 

News flow will be key…

Blokland says the Covid-19 news flow will be key, as second waves of infections are starting to emerge in Asia and Europe. “Better tracking, better testing and better treatments mean fewer hospitalizations and deaths, reducing the odds of new lockdowns,” he says.  

“In addition, we are getting closer to the announcement of a working vaccine, which can be produced and distributed globally. At the same time, we expect the global economy to keep improving, even though the low-hanging fruit has been picked. Activity levels are continuing to increase.” 

“Monetary conditions will stay extremely accommodative and central banks will act, if it is deemed necessary. Equities have the ability to discount this news flow, much more so than bonds.” 

… including the US elections

Meanwhile, the battle ahead of the 3 November US presidential election between Republican Donald Trump and Democrat Joe Biden could upset sentiment, Blokland warns. “The US elections are among the potential catalysts that can derail the equity market rally,” he says.  

“As economic circumstances continue to improve, and Covid-19 cases drop, President Trump’s odds of winning a second term are likely to rebound. This would fuel discussions on fiscal stimulus and debt sustainability, which are less likely to occur in the event of a Biden win. To be clear, any doubt on stimulus will translate into risk markets declining.” 

“A clear setback in the time-to-market of a Covid-19 vaccine would also hit sentiment. Markets are currently pricing in the announcement of a ‘vaccine game changer’ anywhere between now and the end of the year. While there are currently eight vaccines in large-scale efficacy tests, no certain cure for Covid-19 has emerged yet.” 

Consumer confidence also a risk

And don’t forget the risk of consumer confidence not fully recovering, he says. “Impacted by massive lay-offs and the slow recovery of the labor markets, US consumer confidence has dropped to a six-year low. Without further stimulus, this would hit consumer spending.” 

“In Europe, consumer confidence has recovered somewhat, but remains significantly lower than the levels seen before the Covid-19 outbreak. Finally, seasonality is a negative. Equities tend to struggle somewhat, on average, during this period of the year.” 


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