4Q 2019 market outlook in 3 charts
Yield can still be found in a low rate, low inflation and low yield environment.
Interest rates have dropped again after the Fed made a second 25-basis point cut in September, lowering the target range for the federal funds rate to 1.75%-2.00%4. And other major central banks have stayed accommodative, with the European Central Bank even making deeper cuts to a record low of -0.5% from -0.4% and restarting bond purchases5.
Generally, cash’s real return and government bond yields will likely remain low. And investors holding only cash also face the risk of inflation eroding their wealth over time. Already, the average annual real deposit rate of Hong Kong was -2.1%6 in the first half of 2019.
Against this backdrop, investors are increasingly exploring other sources of income for their investment portfolios. We do the same, by investing across multiple asset classes for potential opportunities and managing risk without overstretching for yield.
Even within a single asset class such as fixed income, yield can still be found, but requires moving along the risk spectrum. In addition to traditional government and corporate bonds, fixed income investing could also extend into non-traditional sectors such as agency MBS3, depending on investors’ investment objectives and risk appetite.
Agency MBS demonstrates defensive characteristics and could be considered as an alternative to US Treasuries in asset allocation. They are issued or guaranteed by US government-related bodies, including Ginnie Mae - a government entity within the US Department of Housing and Urban Development - as well as Fannie Mae and Freddie Mac, which are both government-sponsored enterprises.
Agency MBS react differently to market changes as compared to equities and traditional bond sectors such as corporate credit. In periods of market stress, agency MBS could provide investors a counter-cyclical and historically uncorrelated return profile to equities and corporate credit, helping to diversify7 portfolio risk.
Agency MBS as a diversifier in times of market stress 7, 8
Just like US Treasuries, agency MBS historically exhibited a similar, if not, lower volatility profile as shown in the chart. Perceived to have direct or implicit backing from the US government, agency MBS still carry little credit risk which is translated into the slight yield premium it can offer versus US Treasuries. The 12-month rolling average yield of US MBS was about 3.2% as of the end of August 2019, compared with 2.4% of US Treasuries.
Rolling one-year volatility9
12-month rolling average yield9
Agency MBS is also supported by currently sound fundamentals in the US economy, which grew 2.0% in the second quarter of 201910 as the Fed moves to help keep the economy on track. In particular, housing demand remains solid. US housing starts11 rose 12.3% to a seasonally adjusted annual rate of 1.36 million units in August, the highest level since June 2007.
With lower rates, yield seeking can remain a focus for investors. And yield can be found even within a single asset class, such as fixed income, in a conservative multi-asset portfolio. Investing in multiple traditional and non-traditional fixed income sectors, including agency MBS, allows for a wider source of potential opportunities, while managing risk without overstretching for yield.
While the Fund invests primarily in debt and equity securities, the issuers of these securities may be located in any country or region, where the fund managers see attractive opportunities to expand income sources.
Within fixed income, the Fund invests in agency MBS, non-agency securitised (such as non-agency MBS or asset-backed securities), global government bonds, high-yield corporate bonds and short duration fixed income.
Based on investors’ investment objectives and risk appetite, learn about the potential benefits MBS could bring to an investment portfolio.