Attractive alternatives for multi-asset managers

Despite significant increases in bond yields, Paul Flood of Newton Investment Management prefers to look to alternative assets as a source of future income within his BNY Mellon Multi-Asset Income fund.

With 10-year US government bonds now yielding more than they have at any time in the past decade, Flood noted that yields for bond investors are rising, at least in nominal terms.

However, with inflation remaining above expectations and a recent US CPI reading of 8.6%, he argued that real yields remain unattractive and central banks are still under pressure to accelerate the pace of increases. interest rates.

“This is leading to bond market weakness and a ripple effect on equity markets as investors fear that policy measures will push the economy into recession, which could lead to inflation returning to target. the central bank,” he said.

Important role

As Flood began to increase the fund‘s exposure to U.S. Treasuries, he said that in general, as bonds wane, alternative assets such as renewable energy, asset finance and music streaming plays an increasingly important role in multi-asset strategies.

In terms of renewables, Flood said battery storage companies that help transition to renewables have seen big improvements in revenue generation and can earn additional revenue by providing spare capacity to the grid.

“Electricity prices remain high, and we expect long-term price assumptions to rise as Europe attempts to reduce its energy dependence on Russia,” he said. . “This should benefit many renewable business valuations.”

Elsewhere, Flood likes the asset finance sphere where ship and aircraft leasing companies have benefited from escalating transportation costs and a post-pandemic travel recovery.

“Our aviation holdings are benefiting as airlines are getting the Airbus A380s off the ground and providing positive feedback on the continued long-term use of the aircraft,” he said.

“These types of assets do not have inflation-linked income such as renewable energy or infrastructure, but in many cases their secondary market value increases due to rising commodity costs, energy and manpower,” he added.

“In addition, companies consider the overall costs of running older assets versus replacing them with new ships or aircraft.”

Music

As the Covid-19 pandemic has largely decimated the live music and entertainment scene, Flood said recorded music revenues have reached around $12bn (£9.8bn, 11.4 billion) in 2020, with streaming accounting for 83%.

“The move to a subscription-based streaming model has transformed the economics of the music industry, improving revenue visibility and enabling significant margin expansion through reduced distribution costs and operating leverage, while as gaming, social media and emerging market growth increase addressable. markets,” he said.

Indeed, Flood believes that people paying for music through streaming platforms represent a significant growth opportunity, especially for audiences in emerging markets such as China, India, Africa and America. from South.

“Another strength of investment in music royalties is that it is relatively uncorrelated to the economic cycle,” he added.

“Music’s near-universal appeal and importance throughout our lives also lends its commercial strength real longevity.”

Sense of obligation

Looking ahead, Flood noted that geopolitical tensions could continue to cloud financial markets in the near term, with the threat of military escalations creating an uncertain investment backdrop but also driving interest rates higher due to uncertainties. higher inflation.

“This suggests a more attractive backdrop for bond investing – at least in nominal terms – but given the current uncertainty around rising levels of inflation, we continue to favor real assets,” he said. .

“As always, we remain focused on our thematic and fundamental approach to stock selection, an approach which we believe will serve the long-term strategy well,” he added.

For Karsten Bierre, head of bond asset allocation in Nordea’s multi-asset team, what’s happening with bond yields in 2022 is “truly historic”.

“There were always going to be increases in interest rates and bond yields due to the world’s recovery from the Covid crisis,” he said. “But we actually saw a 30% drop in the long-term Treasury index – which is crazy.”

Flip the clock

In fact, Bierre noted that the decline we’ve seen since yields bottomed in 2020 exceeds the losses bond investors suffered in nominal terms in the 1970s.

“We all remember the financial crisis, which was a terrible time to invest, but the drop in high-quality European corporate bonds actually exceeds the drop that investors faced during the financial crisis,” he said. he declared. “There really was nowhere to hide.”

Apart from Covid, Bierre said investors need to go back to the years following the European sovereign debt crisis to get the returns seen today.

“That makes me somewhat constructive on fixed income returns going forward,” he said.

“If we see a more substantial slowdown, we will of course see some pressure on corporate defaults, but companies are doing well in terms of credit fundamentals.”

Not only is net debt to earnings at the lowest level since the 1970s, Bierre noted that household and corporate savings rates are positive, which he says may not be good for growth. future, but is positive for credit fundamentals.

“It’s still a challenging environment and there’s a risk that yields will rise – at least temporarily – and credit-at-risk spreads could also rise,” he said.

“As a bond investor, you need to adapt to the environment and be more flexible in your approach.”