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December 17, 2020

Navigating Our Portfolios Through the COVID-19 Storm

By Bonnie M. Wongtrakool

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Recent vaccine breakthroughs have injected some sunshine into the ongoing devastation of the COVID-19 storm. Though the fight against surging coronavirus infections goes on, the upcoming vaccines should provide a bridge back to more regular daily life for many people over the coming year.

With an eye toward the future, we assembled a cross-sector Post-Pandemic Task Force this past spring to discuss the outlook for fixed-income opportunities within a number of sectors that have been most impacted by the virus. These sectors include airlines; commercial real estate including retail, office and hotels; emerging markets; energy; and state and local municipalities. The post-pandemic committee complements our Coronavirus Task Force, which has been closely monitoring the medical developments related to the virus, and which now expects major developed economies to reach herd immunity levels by the second half of 2021.

Throughout the crisis, Western Asset’s base case has been that the scientists would ultimately find solutions to control the virus, but not without twists and turns along the journey. So despite our optimism for human innovation, we have remained rigorous in our analysis of investment opportunities and worked to identify high-conviction trades with solid fundamentals as well as attractive valuations that could weather a variety of scenarios.

Vaccine approvals have come slightly earlier than expected—a most welcome surprise to all. Nonetheless, we remain respectful of the complexities presented by vaccine supply chains and patient compliance. Although vaccines should reduce tail risk, we continue to own Treasuries as a hedge to protect against potential setbacks. Even at today’s lower rate levels, we expect that Treasuries will maintain a negative correlation to risk assets during periods of volatility. In addition, we expect rates to remain supported given the Fed’s commitment to bolster employment growth beyond the pandemic, particularly for low-income and minority workers. These groups were able to achieve employment gains without pushing up inflation when the last recovery was well underway. The Fed now hopes for a repeat performance to help address the income inequalities that were already widening pre-pandemic.

Our portfolio construction early in the crisis included a sizeable overweight to high-quality corporate bonds, as we believed many investment-grade issuers were trading at extremely dislocated prices relative to intrinsic value. But over this year, we’ve also opportunistically deployed capital in some of the sectors hit hardest by COVID-19, including those deliberated by the Post-Pandemic Task Force. Although we expect uncertainties in these sectors to remain even after vaccines are distributed, we have selectively invested in securities from issuers that our research team views as better positioned to weather post-pandemic shifts.

We view recent vaccine approvals as a "gamechanger" and are currently evaluating opportunities to rotate out of fairly valued corporate securities into sectors that are still underpriced relative to our fundamental analysis and outlook. Nonetheless, we remain fully cognizant of the pressures that may linger on such sectors after mass inoculation. As always, we remain disciplined and diligent in our search for attractive risk-adjusted opportunities.

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