Where are the Opportunities in Fixed Income? - David Zahn, Franklin Templeton.

Yeah, I think the fixed income market was very similar to what we experienced in equities in that when we had that big drawdown back in March, we saw that risk-off went on in bonds as well as equities. Credit widened, high yields sold off. Things like gilts and treasuries and bunds all rallied because people were like, okay, well, there is something wrong. And then once we started to see the central bank response, which we all knew was coming, it was just how quickly was that going to come. Really kicked off by the Fed that they're just going to start buying a lot of fixed income to help create liquidity in the market, and followed up by the ECB and the MPC. You saw that these markets came back. And so we can make a lot of money in fixed income with volatility. By shifting out of less risky assets or cash, because we entered the year with quite a bit of cash, into corporates, we actually were able to get quite a good return last year from the rebound. And since then we've seen that riskier assets in fixed income have continued to do well. You've seen that credit spreads have tightened in corporates, IG and high yield. We've seen that within Europe, one of the big areas of focus has been the spread of peripheral government bonds versus the core government bonds. So you've really seen this huge compression of fixed income assets onto the risk. And now we're sitting here with rates relatively low in most places, UK included, and the next question is what's next? What's going to happen? And I think that a lot of people are talking about we're going to have inflation. Now, I think that there will be some inflation in some countries, but inflation tends to be more regional rather than a global inflation. And so in Europe, no chance of inflation in the near future. The ECB zone forecast for three years is 1.3%, so they see inflation coming back but not getting close to their target. In the UK, we probably will see a little bit of inflation, but that's probably more due to the disruptions over Brexit, and that will be very much in certain imported goods, and then that will calm down. And the US, we do expect that we will see a little bit of inflation kind of into the middle of the year, but it's difficult to see where we're going to find really durable inflation from that. You're going to go, okay, inflation's just going to keep going and going. And so we think fixed income will probably stay around these levels for a while until we kind of see the economies start to recover. And it really is that recovery that's going to be key in all countries because we see where the equity markets are and we see where the fixed income markets are, and then we see where the economy is, and they're not at the same place. And we need to see those two kind of meet. And it should be because with all the fiscal stimulus and monetary stimulus, the economy will come back once we get out of COVID. But we do need to see that, and that may in different countries take years. In Europe, I expect it to be several years, UK several years before we kind of get back to that level. So in that environment, central banks will continue to be very accommodative. They won't want to pull away too early because they've seen what happens if they do that. So I think rates will remain quite low.

Well, it's interesting because obviously money is fungible, it goes wherever it wants in the world to find investments. And you've seen that Japan has been doing yield curve control for quite some time and keeping the long end of yields lower. We've seen that in Europe they're attempting to do similar things through their PEPP program and by keeping yields low. So yes, you might see some steepening in some yield curves, but then investors just go, well, I can get so much better yield by going there. And hedging costs are relatively low now because basically yields are pretty much zero in most developed countries. So to buy a bond and then hedge it back into your base currency doesn't really cost that much. And so I think that you will see some volatility, but I don't all of a sudden see that you'll see big bear steepeners.

Yeah, well, I think that we have a lot of potential risks in this post-vaccine world. I think people are kind of thinking, well, we all get vaccinated then everything's okay. And obviously that is a great step forward, I'm not trying to diminish that at all, but there are a lot of potential policy mistakes that could happen as we exit, be it by central banks raising rates when they do it too early, by governments cutting off spending too quickly, raising taxes to pay for all of this spending they've done over the last 12 months, 18 months. And so I do think there are risks to that, and so that's why I think fixed income is still a good part of your portfolio because it will help balance out some of the other parts that are a bit more risky. And so I think from that perspective we really need to focus on what are the risks going forward.

Yeah. So the areas where we feel that there's some good value are emerging markets. We do think emerging markets offer value, but you have to be very selective. So you kind of need to have an active manager to do that. I think in general, I obviously am an active manager, so I believe that we're entering into a time period where active management should do really well just because if you do get any move in rates, being able to make changes, it can change quite significantly. And so I think from that perspective we can add a lot of value. We're also in high yield and high quality high yield in some of our accounts. We really like that area just because you have double Bs, some people won't go down and buy them, but yet the amount of additional yield you get in double Bs compared to triple Bs is quite substantial. And so it's a way to get some extra carry in your portfolio. But I also think you want to have some defensiveness too. So in our European and UK accounts, we do have some longer duration fixed income bonds which we don't actually expect to make a lot of money off of, but it helps balance the portfolio when you get these days where there's risk off, credit is selling off, equities are selling off, those bonds do well. And so I think it is kind of building that portfolio that has resilience. And I think the other big trends that people really need to focus on, and it's starting to happen more in the UK but it's happening much quicker in Europe, is the sustainability of your fixed income. And I think green bonds, and we're seeing huge demand into those areas. And I think that you'll see more and more flow into that. And so assets that are focused on sustainability should do better going forward. So I think that's a major trend within fixed income as well as the broader financial markets.

All right, thank you very much.