John Pattullo
Head of Retail Fixed Income,
Henderson Global Investors 



Jenna Barnard, CFA
Deputy Head of Retail Fixed Income,
Henderson Global Investors 

Turning Japanese?
A disinflationary pulse is rippling across the world. European companies are holding mountains of cash, which a decade ago would have burnt a hole in the pocket of any chief executive, yet M&A and CAPEX activity is muted. Despite the ultra-cheap money, European consumers and corporates are in no mood to borrow.

Richard Koo, economist at Nomura, calls this a “balance sheet recession”. Hailing from Japan, which is still struggling with the deflationary forces, he notes that when the household and corporate sectors are engaged in balance sheet repair only fiscal stimulus can properly invigorate an economy, monetary stimulus merely leads to mini bubbles in asset-prices. Witness the U.S. stock market at an all-time high or UK house prices near record levels yet the CPI is below 2% in both countries.

It is still unclear whether we are truly recovering from the great financial crisis. In 2010, markets were debating when interest rates would rise from their lows, four years on and we are still having that debate.  Europe’s economy remains anemic so fresh urgency surrounds QE and whether the ECB will engage in U.S.-style purchases of sovereign debt.

Subscribing to the balance sheet recession thinking has served us well, but we have to keep an open mind. We remain alert to signs of inflation, looking at wage indicators and the demand for credit as reflected in the major bank lending surveys.

Perhaps this is symptomatic of a world that is struggling to shake off the mindset of the last few decades, convinced that inflation is around the corner. The reality may be that we are all turning Japanese and may have to get used to a “secular stagnation” low growth, low inflation world. However, not a bad environment for a fixed income investor.

For more information on Henderson Global Investors please see our profile on page 72.

Gerald Buetow, Ph.D., CFA,
Chief Investment Officer,
Innealta Capital

Duration and Sector Exposure Decisions Paramount
Risk-markets have been lulled into an unnatural sense of calm and certainty by the Federal Reserve’s unprecedented monetary policies. Never in the history of capital markets has monetary policy played such an exclusively crucial role in asset valuations. As the Fed ends Quantitative Easing III, tremendously difficult questions arise regarding what the interest rate dynamic will look like as they attempt to manage policy rates using never before used tools. Moreover, will such operations even transmit into the real economy with a leveraged ratio that would make a hedge fund blush? How will spread and mortgage products react? Currently, markets are assuming a seamless transition into the unknown. As a result, duration and sector exposure decisions will prove paramount to the success of portfolio and risk management.

Most plausible progressions from here, in our view, involve generally increasing volatility among risk markets, in no small part driven by greater investor uncertainty in regard to the Fed’s post-taper management of it’s now grossly bloated balance sheet. We also expect rates to generally rise, and while our prognosis is for a relatively slow uptrend, we believe investors should consider the not-unlikely scenario in which the rise is more rapid.

We thus will continue to seek a careful balance between exposure to credit and duration, focusing on sector selection to enhance yield, improve diversification and maintain conservative posturing to minimize potential impacts from spread widening and term structure steepening. We favor shorter-duration domestic exposures that can enhance portfolio yield, while finding attractive yield / duration tradeoffs and diversification opportunities among emerging market exposures. Still, we retain a heightened sensitivity to credit risk, given the potential for spreads to gap out on changes in rate expectations, in addition to the potential for greater disappointment in macroeconomic growth.

The progression of monetary policy normalization remains highly uncertain. And the prospects for broad gains in macroeconomic growth are weak, with arguments for incremental weakness gaining credibility. This potentially disorienting environment demands a calm demeanor, as much as it does quick hands. We therefore favor a conservative stance to maintain our composure and flexibility, with our analytical and trading tools honed to take advantage of opportunities this long-overdue process is likely to produce.

For more information on Innealta Capital please see our profile on page 74.