Columbia Threadneedle’s Tannuzzo comments on ‘an unusual year’ in fixed income
In this most interesting of years, fixed income ETFs have enjoyed the best of times and the worst of times. Gene Tannuzzo, Deputy Global Head of Fixed Income at Columbia Threadneedle Investments, which has USD498 billion in assets, comments that year to date, fixed income returns look ‘very average, but they arrived there in an unusual way’.
Tannuzzo is the lead portfolio manager for the Columbia Strategic Income Fund (COSIX) and oversees its smart beta ETF version, the Columbia Diversified Fixed Income Allocation ETF (DIAL), which celebrated its three-year anniversary in late November, with category-leading performance, soon after reaching USD500 million in assets.
“High yield has been very positive but in general, there have been one, two or three percentage points of performance on credit sensitive assets, and 6 per cent or more on government assets this year,” he says.
“We have learned a couple of things this year. I get very frustrated when I hear people say that what we saw earlier this year was a liquidity crisis. There were significant challenges but any time an economy goes down 30 per cent in one quarter something else is going on.
“We have never seen a large scale closure of the economy with financial markets staying open before, certainly not since post the Second World War, and that is a fundamental change first and foremost that rivalled 2008, and was worse.
“The degree of forced sellings pushed yields on short maturity high quality assets to levels far removed beyond their fundamental value purely because investors were selling not what they wanted to but what they could.”
Tannuzzo comments that the double-barrelled response with a monetary policy that used ‘all the tool kits and new tools’ saw the US’s Federal Reserve buying corporate bonds, but also the scale of the fiscal response across Europe, the US and the US was so significant that it prevented a collapse in consumer incomes.
Personal income data in the US reveals that consumer incomes were higher just a couple of months into the pandemic due to payroll schemes and furlough arrangements.
“These kept income in consumer pockets which helped investors get comfortable with the fundamental story,” Tannuzzo says.
Supported corporate markets meant there was an interesting contrast in which the first quarter government bond yields plummeted lower and credit spreads spiked higher but in the second quarter credit spreads and liquidity recovered.
“The new regime in which we find ourselves is one we have seen before after the global financial crisis,” Tannuzzo says. “We are at the early stages of the recovery and it will take years, but even as the economy gets better, monetary policy will remain accommodative and bond yields will stay low.”
He comments that treasuries have posted strong returns. “We see the returns this year far outpacing the future returns and it is hard to repeat those gains,” he says. “Credit markets have made an incredible recovery in the last six or seven months.
“The important implications going forward is that investors have found that they need to get income from somewhere and that has to be outside trad government options.”
Investors are now looking at credit structured products and more global opportunities.
“That makes sense and will continue,” he says. “Not every entity, not every consumer company or country can survive the new Covid realities which is that there is generally a pretty stable demand for goods but uncertain demand for services.”
Tannuzzo believes that this will come back in time. “But the longer we are in a lockdown environment, the more permanent our trade off and life choices are becoming,” he says.
“In six months we might all be vaccinated and we can get on a plane again and go to a meeting, but our companies have learned that this virtual model works pretty well.
“When we are healthier, I don’t think the near term trajectory for airlines, hotels or cruise ships will be back to where they were a year ago.”
He comments that if the investor is looking to credit to generate income, if they go to the most Covid impacted sectors the quest will be futile. “There are several themes that will be with us for a while as a result and it is tempting to say it’s a last ditch effort to find yield.
“We will be in a low yield env for a while and we may have thought we might rid ourselves of this but we are right back in it again and will be for a while even with some gradual economic recovery.
“We will see new product launches which might push the envelope too far but some will help investors better position portfolios.”
Tannuzzo comments that the traditional bond index constructon is fundamentally flawed, as the market cap weighted methodology was based on equities. For equities, that means that the biggest exposure goes to the larger, most successful companies.
“For bonds, it’s the opposite. A market cap weighting scheme gives greatest exposure to the most indebted companies and the fundamental flaw creates opportunities for a better and more strategic construction, maybe accessing an asset class you haven’t accessed before. Fixed income ETFs will continue to evolve and I will see greater proliferation over the next five years.”
It’s been three years of managing an active fund and a passive smart beta ETF for Tannuzzo, a time he describes as ‘a journey’.
“My first conversations internally with marketing were, ‘how is this going to cannibalise my existing active product’ and they were off base because what I find is that investors are not often saying tell me about your active strategy and your passive strategy.
“Investors are either looking at active or passive and not comparing one to the other but the population who is exploring passive products is growing very quickly, so I have more conversations about why our passive product is better than our competitors, rather than our active fund.
“Folks are understanding you can have something passive, but it’s not a pure senseless robot. It incorporates principles of investing but with the attributes of an ETF, with its easy to understand, low cost simplicity.”