The long-term effects of central bank intervention on emerging market asset values

Randy Brown, Chief Investment Officer at Sun Life Insurance explores what Federal Bank interventions are likely to mean for insurance investors generally and fixed income investors in particular

Insurance Investorposted on Monday, October 12, 2020

Randy Brown, Chief Investment Officer at Sun Life Insurance

Insurance Investor: What is your oversight at Sun Life?

Randy Brown: I oversee the whole global portfolio. 
We have offices in the U.S. and Canada, as well as in seven countries in Asia in terms of balance sheet assets.
Five of these we manage directly and two are managed via our joint venture partners in China and
India. For the other five countries, we have investors on the ground in the local market.
"Non-fixed income asset classes are a small but growing part of the balance sheet"
We have exposure to public bonds as well as in non-public fixed income asset classes, particularly private debt and commercial mortgage loans, among others.
Our portfolio includes real estate equity and some public and private equity.
Being a large life insurance company, the bulk of our assets are in fixed income, but these aforementioned non-fixed income asset classes are a small but growing part of the balance sheet, with equities at around 3% and real estate around 4.5%.

Insurance Investor: What factors do you believe led the Fed towards intervening in financial markets to the extent that they did?

Randy: I feel that the Federal Reserve did that because the magnitude of the impact was so great and so sudden that they felt that they had to step in to support the markets.
This crisis is very different than the Global Financial Crisis. It is a health crisis which led to the global economy shutting down overnight. This has never happened in many of our lifetimes or in the market itself.
The Fed felt that they had to react quickly and with no uncertainty about their commitment to stand behind the market.
"This has never happened in many of our lifetimes or in the market itself."
Because this wasn’t triggered by a credit cycle event or credit cycle dislocation, it led to a pretty serious dislocation in even higher quality corporate bond spreads and market liquidity.
There was a period in March that felt pretty severe, which I believe is why they stepped in when they did.

Insurance Investor: What has been the impact on asset availability and selection for investors?

Randy: The Fed’s reaction was equivalent to that of Draghi during the EU’s crisis, insomuch that they would do whatever it takes.
Treasuries felt a pretty severe reduction in yield and the Fed is taking a good part of new issuance out of the market, essentially squeezing out the private sector.
"The Fed’s reaction was equivalent to that of Draghi during the EU’s crisis"
They also created a floor under corporate bonds to a certain degree, for both high grade and, surprisingly, high yield. 
The corporate bond market reacted pretty favorably in response to this. That being said, it has retracted a lot of its widening, but not all of it.
The corporate index was around 130 (on August 5) in the U.S., but probably started out with spreads in the high 80s. We are still wider than we were, but significantly tighter than where we had been.

Insurance Investor: What effect has this had on fixed income investors?

Randy: It has definitely had an effect on fixed income investors. I would opine that this is financial repression for any form of saver, such as pension funds, life companies, retirees, etc.
When you have a 30-year Treasury yield at 1.2% and we are seeing real rates in negative territory across the curve, this is punitive and is having a big effect on all of us.
This flattening of the yield curve is bad for all of those segments. It has pushed every investor into riskier assets in the search for yield.
"I would opine that this is financial repression for any form of saver, such as pension funds, life companies, retirees, etc."
There are different forms of risks that different companies seem to embrace. Our flavor is doing more of what we have been doing for a long time, which is us willing to take liquidity risk.
A good part of our portfolio focuses on the non-public space, which we originate and manage ourselves.
Private debt still pays, relative to government agency or high-rated structured finance assets. This is especially true relative to other public alternatives.
However, every CIO will have their different risk of choice. Some are taking on more credit risk in the public space, while others are going into middle markets and high yield or esoteric ABS.

Insurance Investor: Do you feel that this will have long-term effects on price discovery and the true value of assets?

Randy: True value has been distorted by this tremendous buyer (i.e. The Fed). It has come into the market and distorted prices, thus creating asset price inflation.
We have seen this for a while, but it was turbo-charged by the Covid-19 crisis. As much as we don’t like it within the U.S., we still look really attractive compared to fixed income alternatives around the better part of the developed world.
"True value has been distorted by this tremendous buyer (i.e. The Fed)"
We are a natural haven for a lot of flows coming in from around the globe. The yield on the BarCap index was something around 1.85% (on August 5), which is practically the entire investment grade U.S. bond market.
This is a historic low.

Insurance Investor: Are investors starting to shy away from passive/index investing as a result of the anomalies in the market?

Randy: By definition, the passive tracking of an index is indicative of a market. I don’t feel that buying the market makes sense where we are today.
This approach is what got investors in trouble in ‘99/2000 with telecoms and ‘07 with financials and autos. Just because there is issuance of debt does not necessarily mean that investors should want to buy it.
I feel that it has become a “pickers” market. You have to be very careful of what you buy, since not all assets are the same and you are not getting compensated for the risk differentials between companies.

Insurance Investor: How much further intervention do investors believe will be necessary to get the economy through this downturn?

Randy: The fact that the future is getting written everyday by the individual decisions of millions of people around the world means that there is still much uncertainty out there.


Instances of unreported cases could create new epicenters of contagion, which can lead to more shutdowns.

We also don’t know what the Covid-19 spike may look like come flu season in the fall and winter.

This is going to be a very uncertain economic re-opening, and adjusting to it will probably take a lot longer than most people anticipate.

Point in hand is the number of companies that don’t have staff coming back to their offices until the New Year at bare minimum.

"We will see more idiosyncratic risk in the back half of the year than we saw in the previous quarter."

Markets also seem pretty well supported without a lot more central bank buying, which may mean that it is much more about the perception that they will continue to be there.

This belief may continue to help drive the market. Since further stimulus packages may be smaller than the first, it may lead companies and individuals to hoard cash.

These are some of the big unknowns, but I feel that we will see more idiosyncratic risk in the back half of the year than we saw in the previous quarter.

 

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