The story of Average Jane
We’re feeling pretty queasy about 2021. Now to be fair, us fixed income managers are rarely the glass-half-full types. We spend our days focusing on the downside, the small chance of losing capital. The upside in getting it right rarely offsets the downside in getting it wrong.
But we’re feeling especially queasy today because almost everywhere we look we see the after-effects of the policy response to COVID-19. Don’t get us wrong; it made for a pretty solid 2020. But its spread across the economy and markets has made this risk extremely tough to assess and manage.
In order to illustrate this, we thought we would introduce Average Jane.
Average Jane runs a small interior design business, she has a couple of kids, a mortgage on her dream house in the suburbs of Brisbane and a supportive partner who works as a traditional fixed income portfolio manager.
When COVID-19 hit, Jane’s business was shut down. She immediately requested and was granted a deferral on payments on her small business loan and mortgage. The bank was happy to provide this because they were able to access the Term Funding Facility (TFF) provided by the Reserve Bank. Jane was also able to access the JobKeeper program for her staff in order to keep them employed and also accessed her superannuation fund to provide a buffer against a prolonged downturn in earnings. She also proactively negotiated a reduction in her lease payments on her office space. Her partner remained employed throughout and saw no change in income but had had a rough month; their daily liquid fund had seen significant outflows during March and they were forced to sell bonds into a falling market which had negatively impacted performance for the month.
After a few months, Jane was surprised to find her bank balance was in better shape than it was prior to COVID-19. Having stayed at home for a few months and cancelling their upcoming holiday to Bali, Jane was able to resume payments on her mortgage and small business loans. She was even able to get a reduction in her mortgage interest rate because her bank had seen a huge increase in deposits and also had access to the TFF mentioned above. Her partner continued to receive the same income and was much more upbeat; outflows had stabilised, their fund’s performance was strong and there appeared to be lots of interesting investment opportunities.
As this was occurring, Jane’s business started to pick up. It seemed that a lot of people had more savings and having spent a few months at home, were looking at ways in which they could upgrade their homes.
In the end, calendar year 2020 turned out to be a better year in terms of revenues and profitability due to increased demand and reduced expenses. Jane’s partner was becoming less upbeat though; with banks no longer issuing wholesale bonds and the Reserve Bank buying up the government bond supply and flattening the yield curve, the prospective returns on their fund had dropped.
Moving into 2021, Jane and her partner had more savings, a business that was performing exceptionally well and a much cheaper cost of debt. They decided to buy a larger home in the suburbs with a home office and a pool. It would mean an increase in the size of their mortgage but the monthly repayments would not increase that much as interest rates had fallen so much. However, frustrated by the lack of supply in traditional public bond markets, Jane’s partner had decided to leave their job as a fixed income portfolio manager and had started investing their excess savings in bitcoin and trading options in the US equity markets.
I’m sure many of you know someone like Average Jane. The Average Jane’s of Australia have felt the impact of the response to COVID-19 directly via programs such as JobKeeper and the Early Access to Superannuation Scheme. They have felt it indirectly via reduced borrowing costs from banks who have benefitted enormously via the Term Funding Facility and deposit inflows. And they’ve felt it further still via increased spending and demand and reduced expenses.
Of course, this has not been the experience for everyone. Jane’s partner the fixed income manager couldn’t stay in a market where yields had been suppressed and financial bonds weren’t even being issued. Average Jane’s retired parents who rely on income from the superannuation fund to fund their living expenses had an okay year in 2020 but the prospective returns had dropped further, in line with the experience of the fixed income fund managed by Jane’s partner. Jane’s eldest child who had just finished university was struggling to find permanent employment.
We hope this little allegory has illustrated that the reproductive rate of the COVID-19 policy response has been significant. Investors cannot ignore the impact of policy across all aspects of their investment portfolios. Policy has suppressed yields and prevented defaults. But it’s also affected some corporate fundamentals in unexpected ways, rewarded borrowers at the expense of savers and hamstrung the efforts of traditional fixed income managers to generate any real positive income in their portfolios.
Policymakers have already signalled that these conditions will not last. Early access to superannuation is no longer available with $35.9 billion ultimately withdrawn. JobKeeper will end in March. Bank access to the Term Funding Facility does not seem likely to be extended beyond the end of June. And right now, markets are questioning the commitment of central banks to their quantitative easing programs.
We wonder what the follow-on effects will be as the stimulus is withdrawn and what this means for Average Jane and her family.
Our view is that 2021 may turn out to be a trickier year for both Average Jane and financial markets alike. Higher inflation expectations, the withdrawal of monetary and government stimulus and the uncertain economic outlook once employment and corporate support measures are reduced may mean much more volatility in both fixed income and equity markets. Investors would be well served to bear that in mind and rebalance their portfolios accordingly.
We aim to provide diversified sources of income by seeking opportunities in both the public and private sectors, whilst maintaining capital stability. For further insights, please visit our website.
MORE ON Fixed Income
Pete is Head of Investment Strategy for CIP Asset Management’s Fixed Income division. He is a portfolio manager for the CIPAM Credit Income Fund and the CIPAM Multi-Sector Private Lending Fund focussed on credit investments in both public and...