Private investors and institutions alike have resorted to hoarding more cash as a result of the extraordinary uncertainty caused by the global coronavirus pandemic.
However, this has exacerbated the risk of a global savings glut, which could further weigh on developed economies around the world as they seek to recover from the coronavirus.
A global savings glut, also known as liquidity hoarding, or ‘dead money’, is a situation where desired saving exceeds desired investment.
Essentially more money flows to those with a higher propensity to save, which pushes savings rates up, so this additional income generated is not spent in the economy.
When the income isn’t spent it doesn’t produce demand, which keeps economic growth low and doesn’t stimulate inflation of goods, but can manifest into financial asset price inflation.
The managers of the £1bn Fidelity Strategic Bond fund, Timothy Foster and Claudio Ferrarese, believe there was already a global savings glut, and the coronavirus has just made it worse.
Ferrarese said that the crisis and policy response has just “accelerated this pre-existing trend”.
“Just look at the savings rate in the UK and the US in response to this,” he said. “People taking extra cheques from the government and essentially saving this money because they’re worried about the future.”
Likewise he said corporates are also not investing. “It's true that credit is available and it's kind of cheap because rates are low and spreads are not very high, but corporates haven’t been using debt to invest.”
Both managers believe this is a continuation of a trend towards ‘Japanification’.
Japanfication is a term used to describe the fact that many of the challenges developed economies face today were already present in Japan 20 years ago.
Those challenges included weak growth rates, low rates of inflation, low bond yields, huge amounts of central bank support, and ballooning debt burdens.
It just so happens that coronavirus has created a global demand and supply shock which will no doubt hamper growth and inflation. The pandemic has also forced central banks to cut rates to virtually zero, and forced governments to take on additional huge debt burdens.
Foster said: “We have had a huge amount of stimulus and this is really a continuation of what was going on before Covid-19.
“Government debt was very high before the virus and is going to be a lot higher following the crisis.”
He argued that this debt can only be supported by low interest rates, “so the overwhelming policy objective is to keep interest rates low”, which is one of the reasons he sees no prospects of rate hikes or inflation on the horizon.
Foster added: “We can't rule out more intervention from authorities in the interest rate markets, controlling the yield curve, and forcing real rates negative. Maybe that’s how we get out of it.”
Japanification in charts
A recession makes the global savings glut and Japanification worse, according to the Fidelity Strategic Bond managers, and every macroeconomic indicator – from unemployment to surveys – are pointing towards a downturn.
“But it’s still too soon to see the impact in terms of the supply chain disruption and how much of that is going to be temporary and how much is going to be permanent,” Ferrarese explained. “I suspect some damage will be permanent.”
“We have had a demand shock and supply also was in shock, now it's coming back, but we need to see if demand is going to be there to sustain this additional supply as the market as industries reopen.”
Both managers were not very optimistic that the recovery will be V-shaped, and foresee a very choppy outlook going forward.
And Foster warned that markets are not pricing in the risk of a second wave and further lockdowns.
“I think a fairly likely risk is that the virus comes back, and with bigger lockdowns,” he said. “This is a big risk that seems quite likely to me.”
In the event of a second wave and further lockdowns however, he said the Fidelity Strategic Bond fund was positioned fairly conservatively with their credit exposure.
“We’re generally a long duration sort of fund,” he said. “I’d expect credit spreads to widen but government bonds to rally and to make money from the government bond end of that.
“Government bonds can act quite well as hedges for equity risks.”
Indeed, a low correlation to equities is one of the three main objectives of the fund, the other two being income and low volatility.
In previous years the fund’s defensive positioning has held it back as risk assets have rallied, however, when you look at volatility and risk-adjusted returns the story changes, the pair noted.
“In the strategic bond space, you’ve got a lot of funds that come in and out, a lot of style drift, and you’ve got a sort of unstable space,” said Foster.
He explained that in an environment where risky assets go up, funds that are heavy in high yield typically earn more, but that performance comes with higher volatility and greater drawdown.
In fact, because the managers were concerned at the beginning of 2020 that the economy was in late cycle, the fund suffered less during more volatile markets in March.
As such, their exposure to government bonds and cash was about 45 per cent going into the crisis, and they were picking up investment-grade credit selectively during the March sell-off.
“We’re balancing the fact that we know there’s going to be a very severe economic downturn, judging incoming information we’re getting about what kind of recovery we can expect, and also offsetting that against where value is in credit and government bonds,” Foster finished.
Ferrarese and Foster took over management of the Fidelity Strategic Bond fund in April 2017 after former manager and veteran bond investor Ian Spreadbury stepped down to retire.
Performance of the fund versus sector since April 2017
Source: FE Analytics
The fund has made a total return of 12.34 per cent versus the sector's 11.16 per cent since the pair took over. It is currently yielding 2.72 per cent, with an ongoing charges figure (OCF) of 0.67 per cent.