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COVID-19

Our Response

 

Updated as of September 21, 2020 

We continue to aim to strike an appropriate balance between our commitment to the health and safety of all our employees, and our obligation as a firm and individuals to continue providing essential services to our clients. To that end, and in line with Federal, Provincial, and Municipal recommendations for businesses, we have implemented a Return To Work Plan that, with appropriate and reasonable safeguards to protect them, will see employees work on site and from home on a rotational basis. We have enacted standard health and safety measures such as: avoiding non-essential travel outside of Canada, maintaining physical distancing between workstations, frequent hand washing, and wearing  a  mask whenever physical distancing is not possible. In addition to these standard health and safety measures, we have enhanced the air filtrations system in our offices by adding air purifiers and high grade filters to our HVAC system to boost the air quality throughout the building. RPIA will endeavour to update these efforts as the pandemic evolves and new expert advice becomes available.

Market Conditions & Opportunities Ahead

COVID-19 has and will continue to reshape the global economic landscape. Six months on from the liquidity crisis of March 2020, investors are faced with a difficult challenge. Equity markets have rebounded strongly and valuations sit at elevated levels by historical standards. In contrast, fixed income securities provide a very low yield, with little margin of safety if interest rates rise. A 60/40 blend of equities and bonds may not deliver the return individuals and institutions are looking for.

We believe investors should be looking to credit strategies as a way of addressing this challenge. Credit is often referred to as “equity light” – a way of generating a reasonable return without the downside risk of equity investments. The performance of credit investments has been strong since March 2020. Looking forward, we continue to be excited by the opportunity to invest in corporate bonds at attractive levels. Uncertainty in the market generally leads to volatility, which we believe represents an opportunity for actively managed credit strategies.

Please contact a member of the Client Portfolio Management team if you would like to discuss our market views or strategies in more detail.

Market Insights

Adapting to a New Bond Environment

January, 2022

Key Takeaways

  • Monetary policy, inflation concerns, and virus variants could challenge bond returns in 2022.
  • Four rate hikes are now expected in 2022, which could put upward pressure on bond yields.
  • We are entering 2022 with very low interest rate exposure (duration) and identifying thematic opportunities related to M&A, new issuance, COVID-impacted sectors, as well as upgrade and downgrade candidates.


2021 was an unpredictable but also transformative year in 
financial markets. We saw concerns around inflation for the first time in decades, the emergence of new variants of the virus, and policies from governments and central banks that changed as often as the wind.

Nevertheless, investments in riskier asset classes such as equities and commodities were rewarded despite the market confusion and volatility, while traditional “risk-free” investments in government bonds were largely negative.

2021 re-enforced the idea that investors might want to adapt their bond portfolios and highlighted how active credit strategies could provide diversification, capital protection and improve total return potential in this environment.

Déjà Vu in 2022

The backdrop for 2022 is beginning to look as challenging as it was in 2021. Monetary policy and inflation concerns could again be the crucial driver of returns with the pace of economic growth and employment dictated by the path and implications of the virus. We believe inflation will be elevated over this next year, but we do not see it getting out of control.

However, it is yet to be seen if the US Federal Reserve ("Fed") can manage inflation that is meaningfully higher than its target rate without evoking even higher inflation expectations and creating a vicious cycle upwards of actual inflation. We are equally concerned that the Fed could increase rates too quickly in the face of inflation that turns out to be less persistent than anticipated and unintentionally slows the economy and its recovery prospects.

Ultimately, RPIA's goal in 2022 remains familiar – limiting or minimizing undue interest rate risk for investors and focusing on providing reasonable returns through credit selection and active trading in companies and sectors that offer attractive risk-reward characteristics. 

Monetary Policy at the Forefront

In mid-December, the Fed announced that it would slow its quantitative easing (QE) program faster than previously indicated and move forward its target to end that process to March 2022. To accomplish this goal, the Fed will double the reduction of its asset purchases, citing elevated inflation pressures and a strengthening labor market for why the economy no longer needs increasing policy support.

One implication of a quicker end to tapering asset purchases is that markets believe it will clear the way for the beginning of rate hikes. Post-meeting, the bond futures market responded by raising its rate hike expectations in 2022 from two 25bp hikes to three. As of writing, the market has priced in a fourth rate hike in 2022

Monetary Policy Tightening Timeline: Tapering & Rate Hikes

Source: CME Group Inc., Federal Reserve. Data as of January 4th, 2021. 

*Market forecasted hikes of Fed Funds Target Rate are based on Fed Fund futures contract prices assuming that the rate hike is 0.25% (25bps) and that the Fed Funds Effective Rate (FFER) will react by a like amount. 

 

Interestingly, the announcement did not result in increased bond yields immediately, but rather after the release of the Federal Open Market Committee meeting minutes in January. This illustrates a point we make with clients often – bond market yields reflect a constantly moving set of probabilities and assumptions that are very difficult to predict and can be irrationally volatile.

This is a key reason we generally kept low interest-rate exposures across our funds and strategies in 2021. We will continue this course until we believe the risk-reward opportunity in rates becomes attractive again.

Currently, real bond yields (adjusted for inflation) continue to be sharply negative, and the extended term premium is not well compensated. We are fortunate to have flexibility built into many of our strategies which allows us to hedge rate risk today. But we can also see an environment later this year after a rise in rates, where locking in higher yields could be beneficial for our investors, especially if we can minimize the downside from yields moving higher along the way.

A Selective Approach to Credit

While credit spreads rallied into the year-end and are at close to historically tight levels, we believe that there will be plenty of opportunities in the investment grade and high yield markets over the course of the year. Even though bond strategies that rely on coupon clipping and more traditional capital appreciation may be challenged in some sectors or companies, we see attractive opportunities to trade companies that can continue to improve fundamentally in the coming months.

We believe the value of a highly active approach combined with a strategy that is less reliant on yield generation and broad spread tightening is crucial to succeeding in this environment.

Our Portfolio Management Team has been focused on identifying thematic opportunities around topics such as mergers and acquisitions (M&A), new issuance, COVID-impacted sectors, as well as upgrade and downgrade candidates, among others.

We continue to think that the environment for financial institutions is positive, especially as rates begin to rise and the quality of the loan books remains strong. We particularly like specialty finance companies such as Aercap (aircraft leasing), which recently took part in an M&A deal that could be a catalyst for price appreciation, and some US and European banks with diversified exposures such as Standard Chartered and Société Générale. We have seen a strong start to new issuance from financials in January, and we believe that rating improvements in companies will materialize in the coming months.

We are also re-balancing our exposures to covid-sensitive sectors that we do not think are appropriately priced and adding companies that are not as impacted by Covid but whose spreads have moved in sympathy. For instance, the volatility during and after the US Thanksgiving allowed us to pick up defensive names such as Netflix (streaming entertainment) at a substantial discount while lowering our exposure to mobility-linked credits like Heathrow (Airport).

With volatility comes opportunity, and we continue to do our work ahead of time to make sure we are ready to benefit from compelling valuations in covered companies during what is sure to be another unpredictable year.


 

 

 

Important Information

The information herein is presented by RP Investment Advisors LP (“RPIA”) and is for informational purposes only. It does not provide financial, legal, accounting, tax, investment, or other advice and should not be acted or relied upon in that regard without seeking the appropriate professional advice. The information is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does RPIA assume any responsibility or liability whatsoever. The information provided may be subject to change and RPIA does not undertake any obligation to communicate revisions or updates to the information presented. Unless otherwise stated, the source for all information is RPIA. The information presented does not form the basis of any offer or solicitation for the purchase or sale of securities. Products and services of RPIA are only available in jurisdictions where they may be lawfully offered and to investors who qualify under the applicable regulation. RPIA managed strategies and funds carry the risk of financial loss. Performance is not guaranteed and past performance may not be repeated. “Forward-Looking” statements are based on assumptions made by RPIA regarding its opinion and investment strategies in certain market conditions and are subject to a number of mitigating factors. Economic and market conditions may change, which may materially impact actual future events and as a result RPIA’s views, the success of RPIA’s intended strategies as well as its actual course of conduct.


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