By Anto Joseph and Ben Streater
Stropro CEO, Anto Joseph sat down with Paul Brennan, ex-Citi economist of 23 years to get his thoughts on the macro environment.
Major events have unfolded in financial markets over the past few weeks. Some are calling the coronavirus pandemic combined with the Saudi Arabia and Russia oil price war a “double black swan event”. In response to these events central banks around the world have taken aggressive action to prevent severe growth risks to the global economy.
Brennan remarked that: ‘’The long downward trend in global interest rates over the past 40 years has seen a range of interest rates reach their lowest levels in recorded history. There is a broad consensus that the decline reflects an increase in the premium that international investors are willing to pay to hold safe and liquid assets, lower economic growth, possibly linked to demographic shifts, and structurally lower inflation. Indeed, all three developments are closely related.”
“From time to time there has been speculation that interest rates would begin to reverse this downward trend and that the turning point could be quite volatile, creating significant volatility in financial markets with wide ranging implications for asset prices. However, there are few signs that the underlying forces of subdued secular economic growth and a glut of planned saving are dissipating. The world remains highly uncertain and shocks to the global economy have largely been negative shocks to demand.”
When we probed Brennan on the current situation unfolding he commented that: “There has been some speculation that the emergence this year of the coronavirus could disrupt global supply chains sufficiently to spur inflation like the oil price shock did in the 1970s. If this were to occur then interest rates could rise sharply. But the coronavirus is also impacting global demand and adding to uncertainty. As a result, forecasts for global and Australia’s growth are being downgraded and there is a renewed glamour for safe assets’’. The additional impact of Saudi-Arabia looking to flood supply of crude to the market by increasing production by with an additional 3million barrels a day, causing oil prices to fall dramatically added ‘’further downside to inflation globally’’.
As Brennan states, ‘’The bottom line is that interest rates are likely to remain at exceptionally low levels for quite some time. And any rise in rates in the foreseeable future is most likely to be quite measured based on what we know about the state of the fundamental drivers of saving and investment.”
Given the recent market volatility, Australian investors are allocating a larger portion of their portfolio to defensive assets to buffer against economic uncertainty. Defensive strategies can include Structured Products, Investment Grade Bonds and Hybrids – which we will explore below.
1. Fixed Coupon Structured Investments
A market that remains relatively untapped in Australia is the Structured Investment market – a $7trillion market globally.
A typical structured product provides tailored exposure to an asset for example equities, ETFs and indexes. In uncertain market environments, Investors typically prefer structured products with predefined return outcomes with downside protection. This gives the investor greater certainty of risk and returns, especially when compared to equity markets.
2. Investment grade bonds
Bonds are fixed income instruments representing a loan made by an investor to a borrower (typically a corporate or government). Bond’s offer a lower risk alternative to direct equities and offer returns between 2-4% p.a. The bond market can be accessed either directly through a broker, or through a fund structure. A bond fund gives you access to a portfolio of bonds with varying duration and returns – providing you with diversified exposure. In either case, the bond or the fund would have a price which fluctuates based on market movements.
Hybrid investments are complex instruments that possess characteristics of both debt and equity. Typically a hybrid would pay between 3-5% p.a. in income and the value can fluctuate with market conditions. Hybrids have been popular due to the premium they pay over investment grade bonds and the regular tax-efficient income that is mostly franked. Investors in Hybrids should pay particular attention to the terms and conditions regarding conversion and write-down provisions of the issuer. Similarly to bonds, the hybrid market can be accessed via fund or ETF, for example Betashares’ ETF ‘HBRD’.
Anto Joseph is the Chief Executive Officer at Stropro and Ben Streater is the Chief Product Officer. This article is for educational purposes and is not a substitute for professional and tailored financial advice. This article expresses the views of the authors at a point in time, which may change in the future with no obligation on Stropro or the author to publicly update these views.