At BMO Global Asset Management we have 22 different bond fund holdings across our range of multi-manager products. Within this 22, three are ETFs in sectors where there is arguably little value to be added by active managers (think gilts and UK linkers).
We also have seven listed vehicles, which are bonds in posh frocks to my mind. Strip them back and they are essentially doing the same job; lending money that they want back and getting suitably compensated for different and usually larger risks until they do. As these are listed vehicles, we will meet with them when they report or have something to tell us as a rule.
This leaves 12 open-ended, more traditional bond funds. We actually met with 26 teams as part of a recent review as we run a squad system, so like to catch up with our reserves at the same time, but also like to challenge everything with new and old ideas that look interesting.
One of the key areas of focus as part of this review is high yield, an asset class that we have had little pure exposure to for a number of years. The point being this is a contentious area, so it is the perfect time to understand how managers are adapting. Currently there is little to draw concern at the fundamental level – animal spirits remain in check and while the terms that lenders are demanding as well as the compensation remain light of touch, we have not seen speculative lending en masse like we have seen previously (remember telecoms in the 90s and LBOs in the 80s and noughties?). As one fund manager put it, finance directors can’t wipe the smile off their faces when they are rolling their debt at such low levels. But that is the point – they are just rolling existing debt.
In contrast, emerging market debt is attractive. Real yields here are obviously attractive but fundamentally economies are in better shape than their developed market cousins. Meanwhile, with regards to currency, it’s hard to know what will happen,
There is money to be made if you think you can spot what you see as a mispricing in the shape of the yield curve. For example, if the five-year rate of interest in five years’ time looks out of kilter with where you or the market is anticipating things will go. I have never heard so much talk about curve flatteners! One of the key developments in recent years has been the divergence of central bank policies around the world. Quantitative easing has thrown a spanner in the works of conventional thinking in its various guises and with it the sanity of many an experienced manager.
Inflation just does not seem a problem. No one knows for certain why but there are many theories as to why wage inflation isn’t coming through – technology was a common denominator whether due to the efficiency of filling vacancies or performing tasks, meaning less skilled workers are needed.
We have been underweight fixed income for quite some time as it just doesn’t feel like you are being paid enough for lending money. Businesses’ historically would have to compensate you more for the fact that they may not be able to pay you back, and that your initial investment may be worth less when they return it to you. Competition to lend to companies has increased as people would rather earn an extra couple of percent more than they are getting for leaving this money in the bank where inflation adjusted you are losing real money.
But there is an embedded assumption that risk is tomorrow’s problem. So what is going to change this situation? I am no genius in suggesting that it will be lender led. If new companies have to pay more to refinance their old debt because there are fewer lenders, the secondary market will reprice pretty quickly.
We are obsessed with trying to work out what the next black swan event will be. Perhaps there doesn’t need to be one. As an ex-colleague of mine at Rothschild’s used to say when the markets fell and everyone was trying to find a rationale, “there are more sellers than buyers” and sometimes it’s just as simple as that. The conclusion we arrived at was that more than ever, it is a case of caveat emptor as return free risks are more likely than risk free returns.
Kelly Prior is investment manager in the BMO Global Asset Management multi-manager team