During the first quarter of 2018 the MSCI World Index, the Bloomberg Barclays US Agg Total Return Index and the ICE BofAML BB-B Global High Yield Constrained Index all declined, returning -1.2%, -1.5%, and -0.3%, respectively. The US dollar was weak with the euro, the yen and gold price appreciating 2.5%, 5.9% and 1.7%, in turn, while the price of Brent crude oil climbed 3.6%. Inflation fears drove US 10-year Treasury bond yields from 2.41% to 2.74%. Looking across the global income landscape, it remains a difficult environment for yield-oriented investors. Interest rate policies across the world are still skewed to the confiscatory, with negative nominal interest rates affecting over $8 trillion of debt (see chart below). These policies are essentially a tax on the savers for the benefit of borrowers. With these dynamics in place income seekers should remain wary as many fixed and equity income investments, alike, appear overvalued.

Portfolio positioning as volatility returns

The recent market environment provided more volatility than has been seen in almost two years, dating back to mid-2016, and featured an almost 10% drawdown in the MSCI World Index from Jan. 26 to Feb. 8. Volatility is generally favorable for multi-asset value investors like ourselves, as we can reallocate capital among asset classes to take advantage of stress. For instance, during the above-mentioned market decline, we drew down on our cash reserves to take advantage of lower prices and increased both our equity and credit exposure by over 5% each, measured at cost.

Risk assets are still expensive, however, and we do not see an overabundance of equities that offer a margin of safety. In addition, with the recent increase in interest rates, the fixed income investments that meet our margin of safety criteria offer somewhat improved returns. As a result, the overall equity exposure of our portfolio, at below 50%, remained towards the lower end of our typical range from 40 to 65%.

The bottom-up search for value and income

One of the key benefits of bottom-up investing at the individual security level, is that global credit and equity income markets are quite heterogeneous and opportunities for value and income can almost always be found.

Today, we are finding income with a margin of safety in certain industries where we believe the threat of disruption is overblown. This is not to suggest that these industries (which include advertising, automobiles and retail) will not face disruption, but rather that the magnitude – or the timing – of the threat may be overstated. In the meanwhile, investors can earn almost double-digit free cash flow yields. To further offset disruption risk, we look for industries where there are many different decision makers, rather than just a few concentrated buyers. When this is the case, shifts in buying patterns may unfold much more slowly than alarmist news headlines may lead us to believe.