Invesco recently released findings from its third annual Global Fixed Income Study an in-depth report outlining sentiments discerned from interviews with 159 CIOs and fixed income asset owners globally. The study offers insights into asset allocation decisions, strategies, and methods of implementation, as well as future intentions of fixed income investors and reveals how they were positioned in the leadup to the market turmoil arising from the COVID-19 pandemic. Highlights from the study reveal: 72% of investors have an allocation to emerging market debt versus 49% observed in the 2018 study; 54% of respondents now believe ESG analysis can unlock hidden value within fixed income; the majority (51%) expressed concern around bond market liquidity, uncertain how bond markets would behave during more challenging periods; and almost half (43%) of respondents believed the end of the record-long economic cycle was a year or less away at the time of the survey. The study surveyed fixed income investors across North America, EMEA and Asia-Pacific (APAC) with a combined AUM totaling $20 trillion (as of Dec. 31, 2019). Respondents included defined benefit and defined contribution plans, sovereign wealth funds, insurers, private banks, diversified fund managers, multi-managers, and model builders. Although the widespread use of unconventional monetary policy and low levels of inflation meant that for many the cycle was seen as hard to compare to those of previous decades, the study reveals an underlying increase in risk aversion among respondents as they anticipated the record run in fixed income markets might be coming to an end. This underlying risk aversion likely put investors in a better position to weather the unprecedented market shocks brought on by COVID-19. Zainab Kufaishi, head of Middle East and Africa, Invesco, said: "Amongst our sovereign and larger institutional investors, we have noted the resilience of client portfolios through the crisis. Long term investment horizons and thoughtful asset allocation had created robust and well diversified portfolios, meaning that even with the volatility witnessed this year, some investors have been able to take advantage of key opportunities in the fixed income markets." As interest in EMD continued to grow, investors became more selective, shifting to country specific allications. The study finds another year of rising interest in emerging markets debt (EMD). A strong run, relatively attractive yields, and diversification have led investors to increase allocations to the sector. 72% of investors now have an allocation versus the 49% surveyed in the 2018 study — a 47% increase (Figure 1). This has been driven by EMEA and APAC investors: 80% and 89% of investors, respectively, have allocations to EMD, compared to just 51% in North America. Moreover, of those invested in EMD, the average allocation is much higher in APAC (7.2%) and EMEA (6.5%) than in North America (3.6%). Specialization is also on the rise, especially among investors attracted by returns (rather than diversification), who prefer country-specific allocations (63%). China is of interest to the 42% of investors who now have an allocation, encouraged by the belief that the Chinese economy and political system offer unique diversification benefits and the lowering of barriers to investment: 62% of investors believe access is less challenging than two years ago. "With low yields on offer in their core portfolios, EMEA investors have piled into EMD to boost returns. 69% of those invested in it have done so for returns, compared to just 25% of North American investors, who tend to see EMD as a diversifier," said Nick Tolchard, head of EMEA, Invesco Fixed Income. "Moreover, investors are no longer thinking of EMD as a monolithic asset class. We're now seeing increased interest in specific markets, which we see as a long-term trend. It's notable that Chinese fixed income in particular is one of the best performing asset classes this year, beaten only by US Treasuries." ESG cements its place in Fixed Income Fixed income investors have sharply increased ESG integration: 80% of EMEA and 69% of APAC investors incorporate ESG into their fixed income portfolios, up from 51% and 38% in 2019 respectively. Moreover, within these portfolios, EMEA investors have the highest proportion of investments covered by ESG considerations, with 34% compared to 22% (North America) and 19% (APAC). North American investors have been the least enthusiastic adopters of ESG, with just 56% incorporating it into portfolios. Gone are the days when investors viewed the adoption of ESG investing principles as a hindrance to investment performance. Only 3% of our survey respondents held this view whereas half of them now consider informed assessment of issuer-related ESG risks as an important tool for investors to enhance their returns. Specifically, issuers who fail to address environmental – the "E" – and governance – the "G" – concerns may face higher borrowing and refinancing costs, with clear implications for the valuation of these securities for investors. 54% of respondents now believe ESG analysis can unlock hidden value within fixed income. 50% of investors that have incorporated ESG within their fixed income portfolios cite return enhancement as a key driver. EMEA investors have the most positive attitude of all regions surveyed: 52% stated incorporating ESG into their fixed income portfolios helped returns whereas just 2% stated it was a hindrance. EMEA investors are also most bullish about the future of ESG, with 34% anticipating these considerations having a ‘much greater influence' in three years' time. Only 15% of EMEA investors expected ESG to be no more influential than it is currently, the lowest proption of all respondents. "Many investors used to assume that integrating ESG would compromise performance, but attitudes have changed. Across all regions, very few investors report that it has hindered returns and, in the case of EMEA, a majority (52%) have said that integrating ESG has improved them," said Tolchard. "Acknowledging the duty investors have to the environment and society they operate in, three-quarters (75%) reference social responsibility as the main driver to integrating ESG factors within portfolios. Further, More than two-thirds (67%) of investors cited stakeholder wishes as a key motivator behind their decision to integrate ESG, showing just how important this issue has become to asset owners and investors." New approaches help to address a bond market liquidity paradox Asset owners were extending allocations to illiquid asset classes late in the cycle. Yet the majority (51%) expressed concern around bond market liquidity, uncertain how bond markets would behave during more challenging periods with the introduction of regulations such as Dodd-Frank and the retrenchment of traditional market makers that followed the global financial crisis. The response in part has been increased interest in strategies that can help improve liquidity and reduce market risk such as block trading directly between customers via ETFs (used by 59% of investors), credit portfolio trading (used by 30%) and wider adoption (56%) of fixed maturity strategies. "Long-term demand for non-traditional fixed income, like private and distressed credit, emerging market debt, and themes like Belt & Road initiative have continued to be of interest in the Middle East," said Kufaishi. "Investors are concerned about liquidity and regulation, especially given the collapse in growth brought on by COVID-19," said Tolchard. "Many are seeing fixed maturity strategies as a good way of harnessing additional liquidity premiums, while at the same time curbing costs and generating stable, predictable returns. We found 56% of investors are using them, including 72% of DC pensions and 66% of insurers." Greater caution in advance of market turmoil Fixed income investors were becoming increasingly risk averse prior to the market turmoil COVID-19 unleashed in Q1 2020. Almost half (43%) believed the end of the record-long economic cycle was a year or less away, with the consensus for a soft landing. 23% identified a bond market bubble with just 29% fearing a major collapse in bond prices. Central bank easing led to low and negative yields, driving some to take on additional risk to bolster returns and meet objectives. The research shows a market that was plagued by fear: fear of losing, but also fear of losing out. Despite some late cycle risk-taking, the confluence of end-of- cycle concerns and fears of trade wars may have translated into portfolios that were better protected from the current, unprecedented exogenous shock impacting markets today. "The perception that spreads were tightening drove many investors to cautious positions. Given what COVID-19 has done to the market, those investors may be relieved," concluded Tolchard. "However, not all investors were so cautious, meaning some are having to manage significant volatility in what would traditionally be seen as high-quality assets, such as consumer goods, oil & gas, and travel." — SG
