Blain's Morning Porridge - September 5th 2017. Is there actually any point investing in bond mar
Blain’s Morning Porridge – September 5th 2017
“They got a name for winners in the world, I want a name when I lose. They call Alabama the “Crimson Tide”. Call me Deacon Blues.”
For the avoidance of doubt – the Morning Porridge is market commentary, it is not investment advice…
Tension re Korea remains high. Seems curious the North Koreans are being so public with their plans to launch another ICBM – perhaps they are planning something, luring the Americans to over-react, or maybe they want to keep Trump looking in the wrong place? What’s occurring? Markets are fretting..
Meanwhile, the real world carries on. The reality is the world is a very different and more certain economic prospect than it was just a year ago. We’ve moved from monetary easing to fretting about growth, rate hikes and taper from all points of the compass. We’re talking recovery from Europe to China. Yet volatility remains low – although I do fear that is complacency.
Changing conditions require a change in approach.
I read some stuff on Bloomberg yesterday about my favourite Sovereign Wealth Fund – Norges Bank and its management of the Norwegian Government Pension Fund. For a state piggy bank that started as a bond fund for a rainy day, they have seen the proverbial light and been ramping up stocks. They’ve made strong returns this year increasing their allocation into equities to 60% and rising.
Now they are further revamping their bond portfolio: focusing solely on liquidity. They are exiting 23 bond currency markets and sticking to Dollars, Sterling and the Euro in the future. Moreover, they are getting out of direct EM and Corporate bond exposure – although that may be addressed indirectly. (UK issuers hoping the Blond, Blue-eyed Arabs will be happy to fund a sterling new issue feeding frenzy should calm themselves – GBP are only 4% of current assets (which will rise to 8%. Dollars 54% and Euros 38%.) – and Gilts will be the likely beneficiaries.)
The key to Norges Bank’s new approach is based upon the brutal reality that: “gains from International diversification are considerable for equities, but moderate for bonds”, according to the fund in a submission to the Norwegian Finance Ministry outlining strategy.
Bloomberg’s excellent Mark Gilbert points out Norges Banks’s problem: QE and the elimination of bond-market volatility means government bond prices pretty much track each other. Japan and German 10-yr debt trade in line, but are two very different risk profiles for the same return. Moreover, the JGB market is far less liquid as a result of the Bank of Japan’s bond purchase programme. The fund concludes owning JGBs gives no diversification benefit, and they could struggle to sell them in the event of a market downturn. Therefore… exit.
When corporate bonds yield half a smidge more than govies despite their greater risk profile, and hi-yield issues return barely a tad over (when the junk indices are full of zombie over-indebted companies that will fold when rates rise), what’s the point investing in non-sovereign risk?
Last person leaving the bond markets please put out the lights..
Of course, there are other ways to improve returns and diversification multipliers – and I’d point to “alternatives”: The investment hypothesis is simple – financial assets (bonds and stocks) have been massively distorted by QE effects resulting in massive financial asset inflation seen in low yields and overly optimistic equity prices.
In contrast, restrictions on bank lending and onerous capital rules have diminished funding windows for banks to finance new business, infrastructure and SMEs, opening up new opportunities for non-banks to get involved across the funding spectrum.
It’s a complex market - reinventing what banks once did. It requires a broad skills approach and specific industry knowledge and expertise. The risks can be mitigated via structure – taking the form of secured senior and subordinated debt, quasi equity, start-up/private finance and equity.
We’ve a host of different deals in our pipeline – all of them providing real returns on real assets. Very happy to discuss the deals in detail.
My favourite sector at the moment is aircraft where we could construct a $500mm+ deal with 8% plus returns based on a pool of aircraft leased to a leading airline, providing solid and predictable residual values at lease end. I’ve also got a number of equally schweet single aircraft deals to talk about – all providing proper real returns.
Or how about financing the construction of an waste-energy plant in the UK with a solid government support base, established feedstock and offtake contracts and a world class construction and operation record to provide solid double digit returns?
Or, what about data centres? We’ve a very interesting proposition to discuss throwing off considerable returns.
And then there is property – I’m looking at a highly innovative private rental sector concept that could work extremely well for large funds wanting access to the sector. (Property provides very safe, dull, predictable, boring returns – especially in the private rental sector which, in the UK, remains very much in the hands of individual landlords. What we’re proposing could well see that market become more institutionalised!
Back to the day job.. but first its coffee time..
Bill Blain