Pandemic intensifies quest for yield

THE QUEST for income has been intense since the 2008 global financial crisis when interest rates dropped to historical lows, and the subsequent chase for income assets drastically reduced yields.

Now, a familiar scenario is playing out in the wake of the Covid-19 pandemic. Global central banks have stepped in with a slew of measures to boost liquidity, cutting interest rates and rolling out fiscal stimulus. Yields are at very attractive levels relative to deposit rates, but volatility could cause whiplash, particularly as markets are still coming to grips with the scale of the expected economic downturn.

The consensus appears to be for a severe global recession as it is unclear when the Covid-19 scourge would be tamed. Meanwhile, strategists debate the shape of the subsequent economic recovery - V, L or W - and when economies might turn around. The answer may take a few weeks to unfurl. In the meantime, the search for yield has become yet more challenging.

Says Leon Goldfeld, JP Morgan Asset Management portfolio manager, multi-asset solutions: ''The drastic repricing of assets in the wake of the Covid-19 global outbreak and the dramatic easing actions taken by central banks around the world will exacerbate the ongoing struggle to find yield...

''There is a risk that investors are pushed into income-generating assets that don't necessarily lower overall portfolio risks. We urge investors to be mindful of risk-adjusted returns when seeking income and to look for a diversified multi-asset income solution.''

Steve Brice, Standard Chartered Private Bank chief investment strategist, says that in forming an outlook, the key issue is more of whether ''we can avoid a feedback loop that leads to significant corporate defaults and thus job losses'', and less a question of how severe the economic weakness might be in the near-term.

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THERE are two scenarios, he reckons. One is that governments fail to control the feedback loop and the global economy goes into significant recession. ''This would clearly be bad for the earning power of companies. The good news is that a significant amount of this is already priced into markets given the magnitude of the market declines.''

A second scenario is that the authorities manage to avert the default/ job loss feedback loop while bringing Covid-19 under control. Mr Brice says: ''This means volatility is likely to ease as we go through the rest of the year, and the recovery in risk assets and income-generating assets would likely be strong.

''Given that nobody can say with any certainty which path we are likely to follow, we recommend investors identify their appropriate 'go-to' state in terms of their investment allocations and put a plan in place to get there over the next six to 18 months.''

Here are insights into key income assets in various asset classes. For comparison, the 10-year US Treasury as at April 6 was quoted at 0.62 per cent; the 10-year SGS at 1.035 per cent. The latest Singapore Savings Bond is quoted at an average annual return of 1.39 percent over 10 years, compared to 1.63 per cent in the previous issuance. A 12-month fixed deposit earned 1.4 per cent in interest rate.

EQUITIES

DBS Bank chief investment officer Hou Wey Fook says Asian equities are yielding 3 per cent on average; some higher-yielding sectors such as Singapore Reits, Singapore banks and Chinese banks have yields in excess of 6 per cent.

''We look for companies with defined dividend policies that can ensure consistent dividend payments, and have a good record of doing so throughout economic cycles. We also prefer those with consistent dividend flows regardless of earnings, low fixed payout ratios (with room to be lifted), and a demonstrated ability to generate free cash flow.''

Such stocks, he adds, may be considered bond proxies for income-generating assets because of the higher yields and better liquidity compared to bonds.

Paras Anand, chief investment officer (Asia Pacific) of Fidelity International, favours emerging Asia equities as an ''undeniably attractive'' allocation over the coming decade. Even with the uncertainties arising from Covid-19, he points to a number of short-term drivers. One is lower oil prices, which would benefit industry and consumers in the region. Two, a decade-long rise in the value of the US dollar, which placed a funding strain on Asian economies, now appears to be turning, thanks to monetary and fiscal stimulus by the US Federal Reserve and other central banks. Finally, valuations have become more attractive.

Schroders says global equity valuations look ''outright cheap'' compared to the past 15 years, but the risk of a prolonged recession means investors should remain cautious. Johanna Kyrklund, the firm's chief investment officer and global head of multi-asset investment, said markets fell to such cheap levels because ''the hit to economic growth that is set to be inflicted by the coronavirus is so hard to quantify... ''.

''As a result, markets are likely to remain turbulent and further declines cannot be discounted.'' Dividends in some equity markets are also likely to come under pressure. The Schroders Asian equity investment team believes that Asian dividend stocks continue to stack up as attractive income alternatives, and ''the case of dividend investing is again compelling'', especially since Asian equity valuations have fallen to attractive levels.

REAL ESTATE INVESTMENT TRUSTS

Analysts have turned negative on Reits despite attractive valuations. The release of a Covid-19 temporary measure bill today is expected to give relief to businesses and individuals who are unable to fulfill their contractual obligations. In a note on April 2, OCBC Investment Research expects tenants to be allowed to defer rental payments for six months, which would cloud Reits' earnings visibility ''by a large extent''.

It said Reit managers may seek to mitigate the near-term cash flow issues by first drawing down on undrawn credit facilities, cutting operating expenses and capex, and seeking support from sponsors. Investors, it added, are advised to take a long term view on S-Reits; understand that DPU may dip substantially in the near term, particularly in the hospitality and retail sectors; and ''have bullets on hand ... for a potential cash call such as a rights issue exercise''.

The FTSE Straits Times Reit Index has seen total returns of minus 27.3 per cent (year-to-April 2), and was trading at a forward yield of 7.8 per cent.

DBS Equity Research in April also turned cautious on retail S-Reits; payout ratios were expected to be reduced from 100 to 90 per cent, and DPU to be also reduced by 14 to 27 per cent.

DBS's Mr Hou points out that S-Reits have recently borne the brunt of ''indiscriminate selling'' in the latest round of de-risking. ''We estimate the cut in DPUs among Reits to be around 10-30 per cent, but share prices for the Reits have dropped to below as if dividends will be cut by more than 40 per cent across the board. During this period of indiscriminate selling, inves tors should make use of the opportunity to switch into Reits where DPUs are more resilient, with a preference for industry leaders with strong balance sheets.''

FIXED INCOME: ASIAN CREDIT, HIGH YIELD AND EM BONDS; STRUCTURED NOTES

Schroders' Asian fixed income team notes that Asian credit is more resilient than the US and other emerging markets due to its lower exposure to commodities. But it is not immune to the recent round of selloffs. ''On a positive note we do not think the current market development is equivalent to the 2008 global financial crisis as the financial sectors are on a stronger footing with more robust balance sheets and capital ratios.''

The team also does not expect widespread defaults in the Asian credit universe on a scale close to what was seen in 2008. Still, ''as there is still high uncertainty on the duration and severity of Covid-19... investors should be prepared for a period of weakness and volatility in the medium term''. On Asian high yield, it says valuations look attractive given significant spread widening, but market volatility warrants caution.

In the funds space, DBS Private Bank's Pierre DeGagne, head of fund selection, focuses on two types of funds for market exposure. These are unconstrained fixed income and multi-asset income funds. In the unconstrained fixed income space, the bank likes the Allianz Global Opportunistic Bond fund which has a flexible mandate but is anchored in government bonds. It also likes Pimco Income Fund which has exposure to the US housing market via government-linked mortgage backed securities. ''Both have demonstrated higher quality and lower volatility,'' he said.

In the structured products space, DBS offers yield-enhancement equity structured products such as fixed coupon notes with a coupon rate of at least 7 per cent per annum depending on market factors. Another alternative is the DBS Multi-Index Liquid Credit (MILC) Note, positioned as an instrument for volatile markets.

The MILC represents the average price of a five-year floating rate note referencing over 400 different corporate issuers. It pays a quarterly headline coupon of USD threemonth Libor + 2.25 per cent.