The past few weeks have seen the crypto markets in turmoil after the implosion of the crypto exchange FTX sparked a broader contagion. Around the same time, there have been anecdotal reports of how crypto traders — presumable punters with the stomach for plenty of volatility — have swung into the other extreme as they bought US Treasury bills instead.
Raymond Sagayam, the chief investment officer of fixed income at Pictet Asset Management, hesitated to comment on what crypto traders are doing. Compared to the Swiss private bank he joined in 2010, they belong to a “quite different” world not always focused on “solid and sound” fundamental investing.
“If you’re telling me they’re starting to invest in T-bills, I would say that’s smart. If I may say so, crypto has been proven not to behave like a haven asset. It is also not a replacement for gold. In an interview with The Edge Singapore, Sagayam adds: “There’s all the turmoil in the crypto market, which FTX has only compounded.”
Sagayam believes that the fixed income universe is now at an attractive level, where investors with horizons of up to the next couple of years have significant margins of safety while enjoying positive returns, even in the face of sticky inflationary pressures and further rises in yields. “Whether govvies or corporates, bonds are offering a lot of value,” he adds.
Sure, crypto punters can quickly ditch T-bills and jump right back to the next hot token, but no matter, for Sagayam sees growing demand for fixed-income investments from asset allocators, including pension fund managers, who face the challenge of consistently generating meaningful returns for a growing pool of in line with an ageing population. “What will they do when the real yields are positive and showing the first signs of meaningful positivity after about a decade and a half? They’re going to start buying bonds very soon.”
As a recent example, when the Italian government bond BTPS reached 4%, it triggered “huge interest” from savings pools. For these pension fund managers, it is a no-brainer: Buy, keep it simple, and have no complexities. “That kind of dimension will be reflected in other savings pools just as local Italians have started to show interest in BTPs given recent yield moves,” says Sagayam.
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Closer to home, a similar surge in demand can also be seen, with bumper issuance thus far this year of Singapore Government Securities bonds and Treasury Bills, as investors chase after yields of more than 3%. “At the end of the day, it is economics 101: Supply and demand. And I think that demand is going to manifest right now.”
Generational events
Sagayam believes his bullish view on bonds is well-backed. The investing landscape is now undergoing the undoing of nearly 15 years of unprecedented ultra-loose monetary policies, which changed the playing field entirely along the way. Since the start of the year, the US Fed has raised rates from near zero to between 3.75% and 4% as it prioritises inflation fighting.
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By doing so, two abnormalities are addressed. “Interest rates are structurally designed and meant to be positive. What good is an interest rate if I lend you money and then get back less money at the end?”
The other abnormality is the inversion of the yield curve. “If I lend you for 10 years, as opposed to three years, I expect a higher interest rate for the 10-year to compensate for the greater duration and risk. And of course, he adds, “we haven’t seen that in recent years.”
Sagayam acknowledges it will take time for the yield curve to start to become positively sloped again, but for now, he is already “happy” for fixed income as there are finally “meaningful, positive real yields” and not merely nominal yields.
For example, real 10-year rates in the US have gone from minus 1% to 1.5% in a few months, and in the UK, from minus 2% to 2%. “At any point in the modern history of investing, the prospect of locking in real rates of 2% in developed fixed-income markets has been attractive. Swings of this magnitude are generational events,” says Sagayam, who has more than 25 years of experience in this space.
“These real yields are an oasis of crystal cool water in what’s long been an unforgiving desert. Undoubtedly, we’ll look back in wonder at the era when some three-quarters of sovereign bonds issued by the richest countries posted negative nominal yields.”
A peak is a peak
However, investors should be careful not to jump right in. The bond universe, by any measure, is both huge and returns offered varies. Sagayam believes that well-diversified short-duration fixed income, with exposure to both corporate and government bond portfolios, offers “exceptional value”.
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Some of these bonds, for example, can tolerate yield increases of between 4% and 6% before investors start to lose money. “This opens up this concept called breakeven. It means you’re getting such a positive yield for such limited duration exposure that you can actually tahan (Malay term for endure) a much more aggressive, forthcoming rise in yields,” says London-based Sagayam, whose parents are Malaysians.
Just like how the US Fed led the way for other central banks in raising rates to combat inflation, US treasuries are leading the way for bonds issued by other developed economies’ governments in whetting investors’ appetites. “I think the key buying opportunity may present itself over the next three to nine months in developed govvies. You want to coincide or be buying as soon as you start to feel that policy rates are going to peak,” he explains.
There is an ongoing debate about when the rates will peak and, when they do, whether they will stay high or start to drop. Fixed-income markets are pricing the latter, but for Sagayam, it doesn’t matter. “A peak is a peak, and markets are pre-emptive. As soon as we start to see a semblance of a deceleration, that is a very powerful buy signal for me.”
However, Sagayam points out that credit cycles take time to unravel, complicating things for investors. During the Global Financial Crisis, the first signs of the subprime market coming under stress showed up as early as March 2007, and it took two years before credit spreads peaked and a few more months later, in October 2009, before defaults peaked. These manifestations — points of stress, peak yields and spreads, and peak defaults — do not dovetail neatly. “We would like them to coincide and make our job much easier. But sadly, that’s not the case.”
He adds that US high-yield defaults are just starting to creep up, reaching just above 1.5%, deemed a low-level mark. “When is that peak going to happen? It is going to be many months later. When is the peak in credit spread (between government and corporate bonds)? I think that story is going to take a little bit more time. It doesn’t mean I would shun corporate paper, but it’s a very nuanced and not an easy answer.”
Fixed income, certain returns
As Sagayam parses the intricacies of fixed-income investing, he is careful to keep sight of the bigger picture. The son of a Malaysian diplomat posted at various times to the US, China, Singapore and the UK, Sagayam has developed an appreciation that geopolitics can often be the overriding dimension in any investment.
“Many times, I encounter investors who are so married to that bottoms-up investment that they think that come rain or shine, that investment, whether it’s equity or whether it’s a bond, it will prevail. The reality is that’s important, but macro and geopolitics matter and can often dominate, as we’ve seen this year,” he says.
As events of the past year have shown, markets are intertwined with macro risks and geopolitics. “There are no two ways about it. You can’t have performing financial markets with an escalating war.”
Russia’s invasion of Ukraine has been blamed for driving up inflation, but Sagayam believes the tension between US and China is more significant for the markets, and the two theatres are different and wrongly compared by the Western press.
“China is not Russia, and Russia is not China. China’s an economic superpower, and if anything has been proven in these recent years, no decisions will be made without considering the importance of maintaining and growing economic prosperity for its citizens. For me, that’s the far more important dimension for financial markets. The Chinese link with so many other emerging and developed economies worldwide is too strong,” adds Sagayam.
He is cheered by the handshake between Presidents Xi Jinping and Joe Biden on Nov 14 at the sidelines of the G20 summit in Bali — something many thought impossible as recent as three months ago. “That’s a great start, and hopefully the start of a long — hopefully not too long — diplomatic journey.”
In the meantime, with plenty of uncertainty still hanging over their heads, investors cannot do worse than turn to, well, fixed income for better certainty of returns.
