Fixed Income Favoured Over Equities After SVB Collapse
With fears rising over the collapse of Silicon Valley Bank, and concerns emerging over the impact on the broader financial sector and global monetary policy, experts at Invesco and Franklin Templeton discuss the impact on financial markets and what it means for asset allocation.
The collapse of Silicon Valley Bank has reverberated across markets, with concerns emerging over the impact on the broader financial sector and global monetary policy, Invesco said in a statement last week.
“Higher borrowing costs contributed to the collapse on 10 March. The worry now is what impact continued rate hikes could have on the sector,” the firm continued.
“Policymakers responded quickly to avert contagion,” said Kristina Hooper, chief global market strategist at Invesco. “However, it does suggest the kind of pressure other banks could come under if the US Federal Reserve continues to raise interest rates.”
“Financial markets are fragile, and these events make investors and the Fed’s job harder,” Benjamin Jones, director of macro research, multi-asset at Invesco, added.
The latest US consumer price index coming in at 6 per cent last week underscores the dilemma that central banks face, with inflation proving stickier than expected, despite a series of interest rate hikes.
“The SVB story proves that financial institutions are not immune to the rapid pace of interest rate increases,” added Charles Moussier, Invesco's head of insurance client solutions for EMEA.
“The insurance industry is in some ways unusually vulnerable to inflation, which has fuelled a rise in fixed income yields, creating sizeable unrealised losses in insurers’ balance sheets. However, unlike banks like SVB, insurers have a far more stable deposit base and typically use large hedging programmes,” he continued.
"The problems within the US banking sector serve as a reminder of the need for liquidity resilience in a world of more volatile interest rates,” Derek Steeden, portfolio manager at Invesco Investment Solutions, added.
Invesco, a UK-based investment manager, has a preference for government bonds and high-quality credit. Within fixed income, government bonds have rallied aggressively with yield curves steepening while credit spreads have widened. “This is a typical risk-off, flight-to-quality reaction,” said Paul Syms, Invesco’s head of fixed income ETFs.
What does all this mean for fixed income investors? Does the SVB event indicate an increased risk of recession, for example? Invesco believes that it’s a little too early to say. Rather than drawing conclusions from this event in isolation, investors will be watching policymakers closely to see how they react, the firm continued.
The asset manager believes that the event is likely to lead to more risk-off positioning. In other words, less equity, more fixed income. And, within fixed income, less high yield and emerging market debt and more government bonds and high-quality credit.
Michael Matthews co-head of fixed interest at Invesco, said at a webinar in London last week: “Everyone is overweight in investment grade credit. Last year was brutal for IGC, but this year higher yields for IGC are back. They are higher than for equities, so investors don’t need to look for risk when they can get high yields in a safer asset class."
Stephen Dover, head of US-based Franklin Templeton Institute, also believes that there are still opportunities in fixed income, mostly in treasuries and high-quality corporate debt, following SVB’s collapse. “In the equity market, there may be opportunities in some financial stocks, but very careful selection is needed,” he said. “While we know there will be reverberations and volatility, there are also potential opportunities,” he continued.
He also believes that SVB is a unique bank, with startup and venture capital firms holding large deposits at SVB that were not guaranteed by the Federal Deposit Insurance Corporation. SVB served half of all venture-backed companies in the US, he said.
“This bank failed because it did not have a diversified client base and lacked strong risk management. There are still concerns with people moving their deposits away from smaller banks to larger banks, which could cause additional instability. However, the recent Fed action seems to have calmed some of the initial fears,” he added.