Top 10 Institutional Investing Trends

The Asset-Backed Securities (ABS) market contains many different types of securities backed by different assets. So to understand the outlook for asset-backed securities, investors need to look at examples of how these asset pools will perform in 2023. The latest research from ABS investment managers inside RFPnetworks suggests that the outlook for Asset-Backed Securities in 2023 will be mixed. Some ABS segments may do well. Whereas some ABS segments may face headwinds.

Examples of Asset-Backed Securities with a positive outlook

In general ABS investment managers seem comfortable taking short duration consumer related ABS exposure. Despite immediate recessionary pressures, labour markets remain tight, wage inflation is the norm, and the consumer finances are in much better shape than the pre-GFC period. This is leading to strong demand for pools of assets that are exposed to both student loans and car loans.

Examples of Asset-Backed Securities where the outlook is mixed

Commercial Mortgage Backed Securities (CMBS) are at the longer end of the ABS duration timeline. Investing in these specific asset-backed securities requires expertise and selectivity. The circle of covid, working and shopping from home has 'irreversibly' impacted the demand for office and retail real estate. This makes the risks and returns on these pools of long duration assets less predictable. There are exceptions which can accessed via Single-Asset Single-Borrower deals (SASB), which is why highly active managers are getting all the calls from investors today.

What is clear is that investors will continue to be interested in asset-backed Securities in 2023. But not just for yield and the strong covenants that bind deal originators. The outlook is also being driven by many other factors that solve issues within Fixed Income portfolios that bonds are unable to solve.

Whether the 2022 bear market is ending may seem a fruitless question. Most market forecasters got 2022 wrong. Even today, 2023 consensus earnings estimates vary widely from high single digits to negative 15%. Added to that are the market historians who point to various pervious market downturns over the last century to support their views. Which collectively suggest that the likelihood of 2023 being a down year is low. But what is the reality. Will stocks bounce back in 2023?

The answer is not so simple. It hangs on a multitude of conditional expectations which make prediction difficult and path depemdent. In particular, the path for inflation and rates. Both of which will impact growth and realisable corporate profitability.

Adding to the complexity are the causes and solutions to the current inflation mix, with both commodity inflation and wage inflation being the most tenacious to tame. If monetary policy fails to bring inflation down without a disproportionate decrease in growth, even the current depressed multiples may prevent a stock bounce back in 2023.

In the meantime, the smart money seems to have a preference to ride out 1Q23 with a portfolio tilted towards the quality, dividends and credit.

One big question today is whether it is too late to hedge portfolio risk. Investors are dealing with three challenges that are impacting their portfolios:

1. Extreme equity volatility.
2. The popular 60/40 portfolio did not diversify risk as expected.
3. Steeply rising rates and an inverted yield curve.

Perhaps the damage is done and the best strategy now is to simply stay invested. Or should investors consider alternatives? Reading around the investment research inside RFPnetworks there is an emerging consensus that the recession will be shallow but protracted. With a potential turning point centred around mid 2023. But what if this is not true. What if the terminal rate required to bring inflation back under control is higher than what the FED now expects. The FED has already revised this upwards since September 2022. Even more concerning for investors is the risk that rate cuts don't come in 2023 at all!

The efficacy of unconstrained, benchmark agnostic or at the extreme, an anti-beta hiding strategy may be needed now. At least, this topic seems to be getting a lot of traction in our research feeds.

Deglobalisation is here and is not going away soon. It represents a powerful reaction on geo-political realities, climate-related imperatives, and global macroeconomic regime change. But it is not just shaking up corporate broad rooms and forcing the C-suite to rethink strategy. It is also forcing investors to adjust their models for lower stock value expectations.

Investors' focus today is finding investment managers that are able to identify the corporate winners and losers from deglobalisation. But that requires managers with a deep understanding of how the corporate world will look in 2030 and beyond.

Deglobalisation has many interrelated dynamics that will affect stock valuations:

- Western governments are introducing incentives, regulation and new demand that encourages firms to embrace domestic production (e.g. The Inflation Reduction act, the Chips Act, and increased defence spending in the US).
- With the end of the four decade trend towards free money, CFO's are now faced with a higher and rising cost of capital. This will heighten capital allocation decision vigilance and ROI hurdles.
- As reshoring takes hold, margins may come under pressure, driven by higher domestic wage and input costs.
- At one extreme, domestic manufacturing may see a renaissance. And at the other extreme, new tech start-ups may need to deliver profitability before securing funding.
- East-West trade agreements may come under pressure as governments compensate for a deglobalised demand curve for their products, which in turn could alter both import tariffs and domestic subsidies.

It will take time before the new deglobalised equilibrium has been found. For now, investors are mapping out the possibilities, how to manage the risks, and how to maximise returns under a deglobalised configuration.

High Yield Bonds were a relative winner in 2022 in a year that saw every fixed income segment except cash deliver negative total returns. The question investors are asking now is whether spreads will widen further in 2023.

Current yields in both the U.S. and Europe are touching high single digits. Well above 10 year averages. High yield is delivering high yield. Which also means that being a corporate treasurer of a high yield rated corporate in 2023 will not be easy.

Refinancing the short duration liabilities characteristic of the high yield market will be very sensitive to the outlook for growth and inflation. Whilst margin preservation and expansion was possible during the covid period, in a recessionary environment, passing through higher input and labour costs to consumers will be tougher.

But these smart high yield corporate treasurers know this. Many have taken pre-emptive action by reducing balance sheet leverage and increased interest coverage to levels not seen since the early 2010's.

But whilst the fundamentals on average across high yield may look decent, investment managers and rating agencies are expecting default rates to rise, albeit from a low levels historically. Despite the current discounted bond prices.

So whilst there is a likelihood of spread widening, the magnitude will be sensitive to the depth and length of the recession, and the monetary policy response. Which in turn raises an even more important question for investors: Where in the rating tables - from CCC to BB - should their high yield investment manager be focused in 2023? Check out all High Yield Bond Investment Manager analysis inside RFPnetworks.

Many Investment Managers today forecast that India will have the largest Real GDP growth globally in both 2022 and 2023 (~7% and ~6% seems to be the consensus, respectively). However, there are concerns that despite strong company fundamentals, valuations are high and it may be time to go neutral or underweight the Indian stock market.

Such a tactical decision does not diminish the long term structural attractiveness of Indian Equities. The economy remains one fifth the size of China and is starting to be recognised as the China + 1 play. The demographics are a story in themselves with so much potential, given the economy's stage of development.

India represents a market with enormous opportunities. And the global institutional world is starting to wake up to these possibilities. We think this may explain why professional investor traffic flowing inside RFPnetworks to India Equity research is spiking.

Whilst necessarily surprising, the Bank of Japan's unexpected decision to raise it's Yield Curve Control (YCC) ceiling is also sufficiently important. In fact, so important that investment managers globally are getting excited about the prospect of a new dawn for Japanese equities and bonds.

But before this excitement spills over into new investor allocations, the question is whether the BoJ allowing 10 year Japanese Government Bonds (JGB's) to trade in an increased range (up from +/25bps to  +/-50bps) versus 0%, is actually a catalytic call to action.

Japan has been fighting deflation for decades. Today the current benchmark rate is set at -0.1% despite inflation hitting a multi decade high in November at 3.8%, well above the BoJ 2% policy target. Yet Japan has also been one of the few countries globally not to have tightened monetary policy in 2022. It should also be noted that Japan is also one of the few countries globally with a Debt/GDP ratio above 200%, of which approximately half is owned by the Bank of Japan.

Put differently, any decision by the BoJ to meaningfully tighten monetary policy at this stage may have less desirable side effects. Neither Governor Kuroda, nor his successor in April 2023, wish to be responsible for extinguishing these early inflationary sparks that could alight a long awaited cytlce of wage inflation, higher consumer expenditure and capex growth.

Nevertheless, as a signal, the widening of the Yield Curve Control ceiling has investment managers and institutional investors seeing amber. Which means they may be changing up a gear in 2023 when it comes to Japanese assets.

For Municipal Bonds, 2022 will be one of those years that investment manager selectors look at closely when evaluating portfolio's in the future. Investment Grade Municipal Bonds posted their worst calendar year performance in 20 years, and third worst on record.

The irony for municipal bond investment managers was that across all maturities and ratings, municipal bonds generally outperformed most other fixed income segments, including treasuries and corporate bonds. And yet, outflows were almost double the levels experienced during the 2013 taper tantrum.

To add psychological pain to performance suffering, this all happened in parallel with fundamentals actually also breaking some records. Local tax collections were higher than the previous record set in 2021. And defaults were contained to specific high yield sectors and lower than 2021.

Relatively speaking, municipal bonds had an outstanding 2022. But investors were simply not convinced. As we enter 2023, perhaps the relative fundamental and performance picture will regain investor attention, and some new municipal bond RFP opportunities will get launched on RFPnetworks.

The back drop is challenging

After a 10 year power struggle, President Xi Jinping now has his own self-chosen cabinet. The immediate changes that followed appear to be focused on getting the China growth show back on the road.

- Zero-Covid policies resulted in consumption, investment and net exports plummeting to 30 year lows, along with real GDP.
- The transition from 'any growth' to 'common prosperity based growth' led to heighten regulations that stifled several sectors of the economy, including the (Financial) technology, internet and gambling sectors.
- Tighter regulations also brought the two decade long growth story to an end in the Chinese Property sector - back in July 2021.

A reversal of fortunes was well overdue

Enter 16 measures to support the property market (sponsored by the People's Bank of China (PBOC) and the China Banking and Insurance Regulatory Commission (CBIRC).

Plus a further 20 measures to relax Covid control guidelines, sponsored by China's National Health Commission (NHS).

Plus the diplomatic efforts by President Xi Jingping to manage a geo-political balancing act that keeps China trading globally.

Unwinding the recent past has a high price

With 50% of China's employment (and GDP) driven by services (including tourism), free mobility is key to growth. But the result speaks for itself - no official numbers are being published on Covid infections levels - the images of Chinese hospitals brimming with people tell the story instead.

Both household and corporate debt remains higher than many developed markets. Unwinding this debt will also take time. Whilst households are once again building up buffers, consumer confidence remains low. And for some property developers, time is all they have before insolvency is inevitable.

For now, investors seem to be in wait and see mode, despite both H and A shares trading a decade lows.

Logistics real estate across both the US and Europe had a record breaking year in 2021. Followed by a strong 2022. Are the long term trends that drove these record years in tact and sustainable in 2023 and beyond?

The two core demand driven long term structural drivers of these record breaking years - e-commerce growth and supply chain reconfiguration - may continue to sustain low vacancy rates and drive rental growth in 2023. But as demand has increased, occupier ESG preferences have evolved. Investment managers are starting to reflect this in the assets they seek for their portfolios.