Aviva Investors’ CIO for liquid markets, Colin Purdie, was feeling more confident about bond markets this year – but financial sector risks have returned and require careful manoeuvring, he tells Nick Fitzpatrick.
After a meeting with Aviva Investors’ analysts, Colin Purdie, the asset manager’s CIO for liquid markets, is assessing the impact of higher interest rates and inflation through the looking hole of America’s Home Depot, a home improvement chain.
“Home Depot had a good lockdown because people spent time and money doing up their houses. But the business is definitely more challenged now.” It’s not because people have finished renovating; it’s because some consumers are struggling with higher prices for materials such as lumber whilst others are feeling the effects of a slowing economy, he says.
Interest rates shot up last year globally as central banks took action to bring down decades-high inflation by increasing the cost of borrowing. In the US, rates went from under 1% in March to over 4% in December. Through the Home Depot microcosm, the rate increases appear to be taking hold. After 40 years of low rates and more than a decade of ultra-low rates, the increases seen in 2022 should be doing what basic economics predicts: reducing spending, slowing economic growth and calming inflation.
The rate increases, coupled with a less severe inflation outlook in recent weeks, meant that by the start of 2022, Purdie had become more positive for fixed income, an asset class that he agrees is much more relevant today than in previous years. He expects the US Treasury to increase rates to at least 5%, while the Bank of England could go to 3.5%.
Fixed income managers have argued that the series of interest rate rises over the past year is a rejuvenator for bonds. The acronym TARA – which declares ‘There Are Reasonable Alternatives (to equities)’ – is in play after many years when the opposite was the case.
“Last year, I had a two- to three-year fairly negative outlook on fixed income, as we expected interest rates to increase at a fairly gradual pace through that period, leading to the price of these fixed income instruments to fall. However, given the high inflation prints over the past 12/18 months, we’ve seen an exceptional number of rate increases from central banks over a relatively short period which resulted in negative total returns for nearly every part of the fixed income market [bond prices fall when their future cash flows are discounted by higher interest rates]. So, what I thought would happen in two to three years has happened in nine months,” says Purdie.
Good total returns from bonds
When bond prices fell, yields for investors rose, making bonds look more attractive, certainly after years of low-interest rates.
Additionally, given the slowing economic growth picture, it is possible that central banks will have to start cutting rates soon, possibly within the next year, when they hope to have inflation under control and when thoughts will turn to avoiding recessions. This would normally lead to higher bond prices.
Purdie says: “The next six to nine months will probably see central bank rates rise and then turn around again, which is good from a total return perspective for bonds.”
Last year, with rates increasing, Purdie said the liquid markets team became “more bullish” on bonds and increased exposure. However, following a very strong January, the firm “reduced exposure somewhat. The fact that bond prices went down around that time could suggest others were doing the same,” he says, but much of the price action was driven by the fear that central banks would have to continue hiking rates in order to calm inflation.
“Last year, I had a two- to three-year fairly negative outlook on fixed income, as we expected interest rates to increase at a fairly gradual pace through that period. what I thought would happen in two to three years has happened in nine months.”
The term TARA has come to replace TINA – ‘There Is No Alternative (to stocks)’. TINA was relevant during the era of low rates. Low rates drove asset prices, including equities, upwards.
But the backdrop to the bond market for over a decade was quantitative easing. The ‘QE trade’ – when central banks mass-bought bonds after the 2008 financial crisis and then again during the Covid pandemic – increased prices and reduced yields.
Falling yields could imply that some corporate bonds are becoming less risky, with investors demanding less ‘premium’ for taking exposure, but the artificial demand of QE thwarted the true picture of bond valuations and fundamentals, says Purdie.
“Low bond yields were not necessarily reflective of the risk people were taking,” he says.
The situation – which was imbued with cheap money – drove up asset prices, including for risky assets such as venture capital and digital assets. Some see the collapse of Silicon Valley Bank as a sign that higher rates are now revealing some poor management and risk oversight practices at certain institutions as well as the quality of some of their investments, exposing the misalignment of risk and return by investors.
Indeed, the current issues within the financial sector highlight that whilst valuations may be more attractive in both fixed income and equities, risks remain, and investors need to be wary.
“Certainly, the recent issues within the US and European banking sectors have tempered further some of our enthusiasm for risk. Whilst the longer-term drivers of the economy and the market remain in place, these episodes can cause a lot of collateral damage for both investors and economies and can remain in place for longer than most people think,” Purdie says.
“It’s been often said, but it is worth repeating – investors need to know what they are buying, and strong fundamental analysis is critical during periods such as this.”
Any landing at all?
In broad terms, Purdie – who spoke with Funds Europe in March – is more comfortable about economies now than he was at the start of the year, though keeping a close eye on any damage emanating from the banking sector.
“There were some pretty bearish outlooks out there last year, but much of that narrative has changed. A lot of official bodies have upgraded growth forecasts, and so some of the near-term risks have dissipated to a degree. The labour market continues to be strong, and although the unemployment picture can change quite quickly, generally, growth is going to be a little bit better than we thought at the end of last year.”
“The recent issues within the US and European banking sectors have tempered further some of our enthusiasm for risk. Whilst the longer-term drivers of the economy and the market remain in place, these episodes can cause a lot of collateral damage.”
Aviva Investors’ economists, he says, consider the US employment picture to be strong, which is supportive for economies.
Official data shows that the US saw around 311,000 new jobs created in February. This was down on the previous month of 504,000 but significantly above the longer-term average of 200,000. Unemployment rose to 3.6%. The data should calm nerves about recession, according to some commentators.
“I think the question could be whether there is going to be a landing this year at all, never mind whether it is a soft or hard one,” says Purdie. “Our house view is that growth will slow, but the upside risk from inflation remains, which could impact how far central bankers will raise rates, which has knock-on impacts for growth.”
A key data point he watches is wage increases, which strongly influence inflation. In the UK, prime minister Rishi Sunak has resisted demands for public sector pay rises, arguing this would increase inflation for everyone.
“I think inflation was anchored for so many years [during the QE period] that there’s been a fairly long lag between inflation going up and this flowing through to wage expectations,” says Purdie. “However, this is now changing given the cost-of-living crisis, and many people view a 2% pay rise as not enough. If we see wage increases coming through higher, then the ability to bring inflation down will become harder.
“We remain fairly comfortable now that inflation will come down, but how that translates into investment positioning is the question.”
He says the liquid markets team is investing around themes such as the reopening of China, healthcare and the “fascinating” area of commodities.
“Our auto analyst this morning talked about how lithium has shot up this past year and has barely dipped at all. Other commodities have been on a rollercoaster ride in the past 18 months, which brings both risk and opportunity.”
Emerging markets, he says, face more idiosyncratic issues but may benefit from the fact that, generally, they started raising interest rates earlier than developed markets. As a result, their economies will have more time to adjust to the higher-rate environment.
Getting trading right
Aviva Investors fund managers access markets from trading hubs in London, Chicago and Singapore. As leader of the liquid markets team, Purdie says that the lower level of liquidity since the Global Financial Crisis (GFC) has increased the importance of “getting trading right”.
“Trading is getting more difficult. Liquidity has materially declined since the GFC, yet more and more capital is being put into the system,” he explains.
“Bad trading can destroy value, and so we have very rigorous processes. I sit down with our head of trading every month and analyse trading costs – where we are doing well and with whom and where we think we can do better.”
Technology is an enabler
“It’s amazing to me how trading systems have evolved over the past ten years, which enable our teams to find liquidity in even the most difficult market conditions. The amount of technology used now is massive and the usage of data, AI and systems thinking to access pools of liquidity has expanded hugely. The fintechs coming through are making the liquidity pools even wider.”
“Ten years ago, to get into asset management, you’d need a 2:1 from one of about ten different universities in only five or six subjects, but that criterion has been blown out of the water, and rightly so from a D&I perspective.”
Technology subjects have increased in profile among those the firm seeks for investment roles. The ability to code, understand data strategies and understand blockchain are sometimes sought from job candidates, Purdie indicates. “Interviewing people now is as much me learning from them as it is them learning from me!”
Purdie – who won the Funds Europe CIO of the Year award in 2022 – graduated from the University of Edinburgh in 2001 with a law degree. His first fund management role was with Aegon Asset Management, where he worked on three corporate bond funds.
He took up a similar role at Aviva Investors in 2010 and, after working in other positions, became CIO for liquid markets in 2021.
The landscape of fund management technology isn’t the only change he’s seen during his career. Take diversity, for example. “Ten years ago, to get into asset management, you’d need a 2:1 from one of about ten different universities in only five or six subjects, but that criterion has been blown out of the water, and rightly so from a D&I perspective.”
Purdie’s knowledge of ESG started in earnest with a socially responsible investment bond mandate at Aviva Investors.
“I became aware of ESG at Aegon but also ran socially responsible investment bonds when I joined Aviva. Steve Waygood, our chief responsible investing officer, interviewed me way back in 2010.”
Purdie has come to view the GFC as a failure of governance and, consequently, as a validator for ESG’s application to investment risk management.
Beyond governance, appreciation for the environmental aspect of ESG has been brought home on a more personal level: Purdie’s wife is an ornithologist who previously worked for the Royal Society of the Protection of Birds and remains a passionate environmentalist.
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