Sober macro view of ‘unknown unknowns’

Theodora Zemek, the global head of fixed income at Axa Investment Managers, talks to Adam Lewis.

Q: You joined Axa in March as the head of fixed income. What changes have you made thus far?


I joined on March 17, which, incidentally, was the day Bear Stearns collapsed. When I started I initially took an “if it ain’t broke don’t fix it” approach. During this time I assessed performance of all our fixed income mandates and the first thing which struck me was the fact that the investment process was closely akin to the way I managed money at New Star.

However the more time I spent with Axa I saw a number of things that needed to be fixed. I have always had my doubts about how much influence on portfolios credit analysts should have.

I am not knocking our team of credit analysts, it is just that the nature of their job means they can miss macro trends and issues because they spend so much time concentrating on balance sheets.

Also, when I started our fixed income portfolio’s exposure to credit was sub-optimal and there was a propensity to stick too close to bond indices and also a propensity to prefer financials. There was also too rosy a view on American markets.

What we have done is to embed the credit analysts with the fund managers, meaning the credit analysts have to be servants to the portfolios. This is a real revolution at Axa.

An antiquated model is the only way to go. Indeed, the one prediction I am willing to make is that the world of complex financial instruments is ancient history. Instead, we are going back to Quaker investment policies. That is, sober, simple and straightforward policies.

Q: So how have you restructured portfolios with this in mind?


It has always been my view that the greatest protection in a credit portfolio is to protect against the unknown unknowns. To do this I use a number of safeguards, one being what I call the reprobate filter.

The premise of this is to beware of any sector that is increasing as a proportion of a standard bond index. In an equity index, a company or sector that is increasing its weighting in the index is a good thing. It generally means that the company or sector is experiencing growth. In a bond index, however, the reverse is true. It means that the company or industry is leveraging itself faster than any other, and thus, raising its risk exposure.

Think of telecoms in the 1990s, motor companies and more recently, financials this decade and for those who are nostalgic, railways in the 1890s.

We also decided that to maximise the value of our process we had to get more of the ideas of the macro strategy group into portfolio construction. To do this we have taken Chris Iggo, [chief investment officer, fixed Income at Axa IM], and created what we call Iggo’s Indicators.

These are 12 key measures applied in the evaluation of markets, eight of which are macro indicators and four are valuation indicators and they are designed to test the portfolios. It is all about putting in place a more systematic way of getting macro advice into the portfolios.

We are also about to introduce what we call the bond bible. In this are what we perceive to be the golden rules for fixed income investing across the fixed income division globally. It is like a checks and balances of all the perceived wisdoms which have helped us out of tight spots before.

This will be rolled off the presses soon, with one version going out to our fund managers, a second version going out to IFAs and a third which will be sent to journalists and our institutional clients.

Q: On September 1 you took over the Sterling Corporate Bond fund. What changes have you made thus far?


The fund is meant to be fully restructured at the end of the month. However, it has to be stressed that I am not changing it with the aim of outperforming the sector.

It is all about protecting capital, generating a reasonable level of income, and providing a decent cash flow for unitholders. So the aim is to have a safe and well diversified portfolio.

The changes I am making to ensure this involve shorting the fund’s duration bets and reducing the weighting in financials. The overweight position we had in financials will simply be redistributed to all the other sectors.

Q: In these volatile market conditions what is the right way to behave as a fund manager?


It is a damn tough market out there right now. But the key thing is that people are still making markets. While liquidity comes and goes it really is not time to panic.

We have reduced positions in areas we felt we had too much exposure, but with everything looking cheap there are plenty of opportunities to replace the less good stuff at good rates.

It is all about not getting sucked into the details and trying to buy yourself distance from market events. In these markets it is all about not taking risk and trying to think about the big picture, not the small picture.

Q: How would you assess the recent moves in the market?


Right now we are too close to the events to be able to say anything sensible. It is difficult to say anything intelligent or meaningful because the specifics are evolving all the time. I think I can say that we are in the scariest markets for more than 25 years and I genuinely do not know what the outcome will be.

I do expect a rise in default rates in the corporate bond market as companies will find it increasingly difficult to refinance.

It is also clear that global interest rates have been too low for too long. Historically, real yields in the UK and the US have been close to 3%, but they have recently been closer to 2%, so it is clear you could borrow too cheaply.

Q: What do you make of Henry Paulson’s $700m bailout plan for the financial sector?


I see the Paulson plan as policy making on the hoof. However, it is absolutely necessary and they had to do something.

However, it is a big “if” that it will go through congress. If it does not I am not sure what it means. From a nationalisation perspective it has to take place.

THEODORA ZEMEK joined Axa IM in March 2008 as global head of fixed income and on September 1 took over the management of the Sterling Corporate Bond fund.