From his viewpoint across the ocean, Legg Mason’s Jack McIntyre sees the euro surviving its crisis - he even holds Italian bonds. But he is quick to add that his fund is underweight Europe.
At the heart of his strategy is to look for bond valuation anomalies anywhere on the globe. That means identifying the big macro themes, and looking at whether these trends are being priced correctly in the various markets.
“Our overriding belief from day one has been that we don’t manage the fund against an index,” says McIntyre. “It’s interesting now how many other managers are shifting away from managing relative to the benchmark.”
Bond benchmarks are peculiar beasts. In equities, when a company like Google or Gazprom expands rapidly in market value, it becomes an ever greater part of the index. An equity manager will do well as it follows the stock during its ascent. But in bonds, a country such as Greece or Italy becomes an ever greater part of the bond index as it goes deeper and deeper into debt and issues more and more bonds. As a bond manager, do you want to adjust your weightings towards the ever-more indebted as they become a bigger component of the global bond market?
“Bond indices are based on the countries that have the most debt – the US, Japan and the eurozone. It gives you a very high concentration in the G3. Why do you want to be automatically in them? By and large, a lot of the smaller bond markets are in a better economic and currency position.”
There’s a simple answer to this question, of course. Liquidity. Only the bigger markets are deep enough to trade in and out of with ease. But Brandywine says it has developed sufficient skill to tackle this problem and its holdings are not so vast that it can’t be nimble.
”The data in the US continues to surprise on the upside. The economy is actually surprisingly strong”
This investment approach takes Brandywine into the bonds of higher-yielding countries, where it also believes it can cash in on currency appreciation. But they still have to be investment grade. “Look, we’re not talking about Sri Lanka or Egyptian bonds. We do have a lot of risk controls in place,” says McIntyre.
The fund’s most significant active positions are in Mexico and South Africa, while on currency it favours Chile.
Having read a double-page spread in The Guardian this week detailing the horrifying, and still worsening, drugs war in Mexico, I find the idea of buying Mexican bonds a touch dangerous. But McIntyre, while acknowledging the country’s social problems, says the fundamentals are sound.
“Already we’ve seen a back-up in yields from 8% to 6%,” he says. “If you look at the long-term prospects of the country, it has a huge young workforce on the doorstep of the USA at a time when the cost of production in China is increasing. You might just see some of that production shift over to Mexico.”
Standard & Poor’s has Mexico on an A rating, which may make it, on paper, more secure than many European countries. “If you look beyond the drug cartels, there are a lot of positive developments in Mexico,” adds McIntyre.
The logic of investing in Mexican bonds, though, dictates that you also believe in an American recovery. Without demand from north of the border, Mexican factories will remain moribund. And, indeed, Brandywine takes a sanguine view on the American economy.
“The data in the US continues to surprise on the upside,” says McIntyre. “The economy is actually surprisingly strong. OK, it’s not 4% growth a year, but it’s more robust than many realise.”
But the trouble with good economic news is that it could translate into higher base rates. The ECB cut rates last week, the Australians are cutting rates and the Chinese are easing. If that process goes into reverse on better economic news, then global bond funds won’t be the place to be. Neither will American dollar assets, as the flight to safety goes into reverse.
But McIntyre thinks we’re some way short of that yet. He reckons we’ll muddle through, but not without a lot of volatility along the way. “We remain underweight Europe. There is still a lot of headline risk in the euro.”