We also favour subordinated debt in the financials space, given the strength of bank balance sheets

We are committed to integrating ESG into our investment approach, across all funds and mandates, as well as within our initial investment processes, in a bid to better manage risks and provide sustainable, long-run returns for clients. The process includes an exclusion list of names we would not invest in. For our high yield fund we invest exclusively through CDS indices whose constituents we do not select, as the index is provided. But unlike investments in equities and bonds, CDS indices do not contribute to the financing of a company.

One issue is liquidity in risk-off moments that can fuel volatility spikes. We therefore recommend not only the use of CDS indices, but also building more balanced portfolios that hold both credit and interest rate duration. Holding interest rate risk makes sense at a time when central banks are not hiking and this will support the portfolio’s performance in risk-off episodes. The latest example of this is the impact of coronavirus on credit. We have seen how holding interest duration has been able to support a portfolio, as the concerns have attracted safe-haven flows into developed market government bonds.

We also see risks building once US-China trade negotiations return, when the more difficult phase two negotiations kick off. Volatility could also pick up as we get closer to the US elections. That said, both of these are not imminent, but will require monitoring.

If we move into a recession, the riskier parts of the market will underperform, and this is unlikely to be any different in this cycle, where high yield would be impacted. However, this is not our base case. We are not seeing any signs in the data that would suggest a recession is imminent. Instead, we are actually seeing data improve off the lows, as the uncertainties of trade and Brexit that were clouding the outlook have lifted.

The high yield market and credit markets more generally have seen plenty of inflows over the past year, with 2020 also starting strongly. As yields within the investment grade market fall, this is likely forcing investors up the risk spectrum and into high yield for returns. With the growth backdrop improving and central banks more likely to ease policy further rather than hiking rates, investors have taken this environment as an opportunity to put cash to work.