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Partner Insight: Exploring the new realities in fixed income

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With debt rocketing, GDP damaged, and business models threatened, RLAM’s Jonathan Platt tells us what is driving his outlook

Jonathan Platt, RLAM's Head of Fixed Income, says the course of the pandemic and the investment implications of alternative macroeconomic scenarios cannot be truly forecast - there are too many variables. But amid market distortions, could fixed income strategies still find the right balance of risk and return?

Eery earthquake

"This is a seismic change in the level of government debt, equivalent to wartime levels," he says, "with the flipside that the interest charge on governments is remarkably low." One key reason is that the clearing price is being artificially set by government agencies.

"We're heading for a situation where the Bank of England will own 50% of the state's stock of debt," he says. "The great unknown is at what point will investors say this has gone far enough - we're taking on debt we'll never be able to fund?" says Platt, with major knock-on effects on the ability of the state to support consumers and corporations. That day of reckoning seems to be a lot further away than people would have assumed a few years ago, he says, but remains unpredictable.

His best guess is that the medium-term government response will eventually combine, "an extension of quantitative easing on a global basis, higher levels of government debt, and tax rises targeted at income, but potentially also wealth, and the more resilient areas of the corporate economy." As the banks discovered in the 2007-9 global financial crisis, government support comes with strings attached.

Recovery realities

He's not confident we will see a V-shaped recovery, though it's one of three central scenarios RLAM considers. "Damage has been done to the real economy and businesses will take time to adjust business models - a drawn out process with real pain when government support is reduced," he says.

For now, "we're in a kind of phoney war with the real economic impact only becoming clear over time," he says. "We also can't assume today's markets are anticipating a particular level or shape of recovery, because they're being significantly driven by liquidity and injections into the financial system," as well as the perceived resilience of the banking sector relative to the last crisis.

Investment implications

The distortions in the macroeconomic landscape mean different things for different parts of the fixed income market. Returns from investment grade bonds will be significantly determined by what happens to government bond yields, which he thinks, "will likely stay low but trend higher over time, with very low, possibly negative, returns for a couple of years."

Risk-averse investors may be happy to accept the return of capital rather than a return on capital, especially given present uncertainty. Very long-dated index-linked bonds have been performing well in the market, even though buying them can guarantee negative real returns over the lifetime of the bond, he says.

In this looking-glass world, duration may prove critical: "I think shorter duration strategies might turn out to give the best returns over and above cash - things like short duration investment grade bonds, short duration index-linked bonds, short duration high yield funds - simply because moves in the yield curve over the medium term mean that some longer-dated bonds will likely suffer," Platt says.

For professional clients only, not suitable for retail investors. The views expressed are the contributor's own and do not constitute investment advice.

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the contributor's own and do not constitute investment advice. For more information on a fund or the risks of investing, please refer to the fund's factsheet, Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk.

All information is correct at September 2020 unless otherwise stated. Issued September 2020 by Royal London Asset Management Limited, Firm Reference Number: 141665, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, Firm Registration Number: 144037, registered in England and Wales number 2372439; RLUM Limited, Firm Registration Number: 144032, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between sub-funds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259. Registered office: 70 Sir John Rogerson's Quay, Dublin 2, Ireland. All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number 99064. Registered Office: 55 Gracechurch Street, London EC3V 0RL. The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal London Mutual Insurance Society Limited is on the Financial Services Register, registration number 117672. Registered in England and Wales number 99064. Telephone calls may be recorded.

For more information please see our Privacy Notice at www.rlam.co.uk. AL RLAM P 0022

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