Over the last few weeks fixed income markets have seen huge volatility, with significant questions about correlations and liquidity thrown up by markets. Central bank and government interventions have moved markets and in these conditions an approach which is active, flexible and unconstrained is crucial.

The Allianz Strategic Bond strategy adopts just this approach investing across the fixed income spectrum, taking a global, unconstrained approach in order to deliver returns from the full range of fixed income instruments. The strategy is different from many of its peers as it has four core global drivers of alpha, rather than domestic ones:

• Duration
  
• Credit
  
• Foreign exchange
  
• Inflation

In addition, in today’s volatile market environment it is crucial your fixed income allocation acts as it should, providing some diversification vs equities to protect the returns in your portfolio. The Allianz Strategic Bond strategy aims to behave like a true bond fund and targets a low correlation with equities, ideal when market volatility is high.

Since the outbreak of the Coronavirus and the subsequent volatility markets have seen this investment approach has been hugely beneficial to clients. The strategy has been able to use its flexibility to position itself to generate returns and offer diversification against falling equity markets.

The strategy is run by Mike Riddell and Kacper Brzezniak, lead portfolio managers who are based in London. Mike has been running the Allianz Strategic Bond strategy since inception in June 2016.

In addition, to potentially leading the post Corona economic recovery China A-Shares offer access to a long term trend in equity markets. The China A-Shares market is slowly opening up to investors and the gradual inclusion in the MSCI indices has the potential to be one of the key trends of the next decade. The first inclusion was on the 1st June 2018 but they still only make up 1% of the MSCI AC World Index despite accounting for nearly 9% of global market capitalization⁽¹⁾ . This begs a key question for investors: how should they optimize their equity allocations to take advantage of this? 

Throughout the volatility of the last months the Allianz China A-Shares strategy has continued to perform strongly, more than matching its strong historical track record. The team lead by Anthony Wong, based in Hong Kong has a long standing expertise investing in the Chinese onshore market which has contributed to the strategies significant success.

Latest updates: William Russell, Global Head of Equity Product Specialists recently took part in a special Citywire roundtable on investing in China with several leading fund selectors across Europe. They discussed how China has reacted to the Corona outbreak, why 2020 is different, why now is a great time to enter the market and much more.

Part 1 - How's the 2020 crash different for today's China?

Part 2 - How to play Chinese equities during the Covid-19 crisis

With global equity markets buffeted by the effects of the coronavirus pandemic in Q1 2020, the long-term orientation of thematic investing has proven its resilience, allowing thematic strategies to significantly outperform the broader market. As social distancing is implemented more and more broadly, education has moved online; as stadiums are closed, e-sports are flourishing; as households stay at home, the company of their pets is ever more valued – these evolutions are unlikely to be rolled back once the crisis abates.

Thematic investing enables investors to participate in the opportunities arising from structural shifts, typically driven by innovation, demographic change, resource scarcity, or urbanisation. Investors are able to invest in a specific theme or themes rather than a sector or region, investing in a concentrated portfolio of companies who could stand to benefit from these changes.

Allianz Global Investors has strived to grow its expertise and product range in this area and this has proved beneficial during the recent market volatility as performance of our thematic funds has held up well, in particular the Allianz Thematica strategy.

The Allianz Thematica strategy aims to stay ahead of the curve by participating in structural shifts in the world, investing in the most promising themes occurring around the world. The fund uses Allianz Global Investors’ expert research capabilities to actively manage both the selection of themes as well as the stocks within each theme. After selecting the themes that we believe will deliver the strongest returns we create a diversified portfolio with an allocation to each of these.

We believe that this means we can offer investors a diversified, adaptable and robust portfolio. The strategy is more diversified than our single theme strategies, as it invests across several themes. Furthermore, themes within the portfolio will change with time and theme composition will constantly adapt as new themes emerge and older themes peak.

China was the first country to reopen following the Covid-19 pandemic and surging costs of imported commodities have pushed up factory-gate inflation to its highest levels since 2008. China has had a deflationary influence on global consumer prices since the 1990s. But low margins – coupled with these rising costs and increased export demand – could lift prices just as inflation starts to pick up in the US and other reopening economies that have made progress in their vaccination programmes. This trend is further exacerbated by supply chain bottlenecks in other emerging markets, which we expect to drive inflation in the short term.

While the supply chain and trade trends could cause an increase in inflationary pressures in certain sectors, ex-China Asian economies such as India, Vietnam, Bangladesh and the Philippines are expected to benefit as companies transfer supply chains. This should further fuel economic growth in these countries as they develop the ecosystem underpinning the supply chains. As a result, within Asia, sectors at the heart of this evolution should be well-positioned. These include telecommunications, clean energy, logistics and packaging.

Businesses based around the trends that are likely to accompany economic growth in these countries – like urbanisation and adoption of technology – should also present opportunities within Asia. These include consumer goods, healthcare and pharmaceuticals.

Easy access to working capital is the lifeblood of free trade. The field of trade finance consists of financial instruments built around loans that provide the working capital to facilitate this trade. There is already a structural shortage of trade finance globally and a faster-growing economy will make the situation worse, while potentially improving the returns available for investors. Since trade-finance instruments typically have very short durations – around 90-180 days – the impact of rising rates would likely be minimal. Moreover, as liabilities run off, new deals can be financed at higher rates. This means there should be only a short delay between rates increasing and investors being able to secure higher offered returns.

If any inflation is part of a wider global reflationary trend, there will also be a resulting benefit to the fundamentals of the underlying credit risk, which should also increase the supply of trade finance deals available. The short spread duration also reduces volatility compared with longer-dated assets.

Infrastructure debt involves corporate-debt-based instruments that provide the bulk of funding for most infrastructure projects. These typically incorporate various safeguards that can provide further reassurance in times of inflation. Compared with other types of corporate debt, infrastructure is a relatively low-risk, investment-grade asset with a long duration that affords investors some certainty around meeting long-term liabilities. Furthermore, infrastructure is not exposed to the same market risks as other publicly traded corporate sectors, so it is less volatile.

Due to the nature of the projects being funded, the organisations behind the infrastructure deals are typically heavily regulated, which adds another layer of protection. Infrastructure projects often take place under a monopolistic or semi-monopolistic arrangement, and those regulators impose high barriers to entry.

Inflation expectations are one of the most important drivers of valuation for assets that have a strong correlation between inflation and EBITDA (earnings before interest, taxes, depreciation and amortisation). This describes a large part of the infrastructure universe, but the impact of inflation varies across infrastructure projects:

• For example, some projects are index-linked to maintain conservative structures. These should see little impact from inflation.
• Other deals are fixed rate, which could lead to some stress when the deals need to be refinanced at higher levels. However, this can be mitigated by amortising structures that both cut duration and reduce the amount of refinancing.
• Some fixed-rate deals finance assets that benefit from inflation, which allows them to de-lever more quickly than expected.

In a sustained high-inflation environment, there will be much more divergence between the best performers and the worst. Typically, the best performers should be those assets that have high margins, a relatively fixed cost base with sub-inflationary growth and the ability to achieve increases in tariffs. Digital infrastructure is a good example of this type of asset. Conversely, some infrastructure assets, such as ports, are heavily exposed to the deglobalisation trend.

Although the degree varies, investments into the equity of firms involved in infrastructure projects typically carry a high correlation with inflation. A portfolio can typically be split into the following broad categories, according to how inflation impacts them:

• Real-return regulation. This determines the real return on capex before overlaying additional compensation linked to inflation movements.
• Nominal-return regulation. This determines a nominal rate of return on capex. This is not directly linked to inflation, but typically will offer some protection against inflationary environments, for example by passing operational expenditure onto customers
• Volume-dependent. This involves assets that are typically able to reflect inflation in their tariffs to customers in the short and medium term.
• Tariff-regulation and long-term contracted. These set long-term revenues at the outset. These are not always adjusted for inflation until the regulation is reviewed or the contract expires.

Of these categories, real-return regulation assets generally provide the best hedge against rising inflation. In fact, the positive correlation means that rising inflation represents an opportunity to increase returns on investments. For tariff-regulation and long-term contracted assets, the correlation is significantly lower, but still positive.

For debt generally, the underlying assets are typically fixed term, and often long term, so cashflows can offer a levered play on inflation.