In an eventful quarter for global bond markets one of the key events was a real flight to quality, with investors favouring in particular short-term government bonds. Corporate bonds underperformed, in particular those in the investment grade and high yield space, as well as emerging market debt.
While this has been the backdrop, Stewart Cowley, the leader of global fixed income and manager of the Newton International Bond fund, says there has also been some profit taking in the global bond sector to pay for losses in other areas. “We have seen some liquidation. In portfolio terms, it’s not as straightforward as bonds good, equities bad.”
Where one has been positioned on the yield curve has also dictated the degree of success in bond investments, says Cowley. “It’s been a big determinant of the overall success relative to the index. It hasn’t been as easy as you would have thought – you would expect global bond yields to be at much lower levels than they are.”
Peter Geikie-Cobb, the manager of the Thames River Global Bond fund, says the key has been the continued theme of deleveraging. “Very suddenly over the last quarter we’ve seen a definite switch towards deflation. There’s been a big catch-up in terms of rate cuts by the MPC [Monetary Policy Committee] and the ECB [European Central Bank].”
Currencies have also had a significant effect on returns. “We think our bond management has been good,” says Cowley. “However, where we have struggled at Newton is being too underweight the dollar. We’re several per cent behind the market because of fractionally incorrect currency positioning. With 20% moves in currencies, if you were slightly incorrectly positioned the effects are magnified. This is deeply frustrating.” However, he says a good call has been to be drastically underweight emerging market currencies.
Stephane Fertat, a fixed income product specialist at T Rowe Price, has favoured the yen and Swiss franc as well as the dollar. Historically, he says, the dollar has not received risk aversion trades, but there has been much unwinding of risky positions, leading to investors buying back the dollar by default.
In Cowley’s view this dollar strength is not sustainable in the long term. “There are some real opportunities in the future. I think these moves will be reversed. The dollar rally won’t go on forever. By not owning the dollar going forward we can save clients quite a lot of money.”
Risk aversion and lack of liquidity, rather than macro fundamentals, are driving bond markets, says Fertat. “Government bonds are trading well because pretty much they’re the only thing you can find in the market. There is some question over how much value they offer. We will see more issuance next year, which will have a negative impact. So far we don’t see any end to that. Governments are doing the right things – throwing everything at it.” However, things will not really change until there is more liquidity and banks are more willing to lend money, he adds.
One source of frustration, says Cowley, is that rational, evidence-based fund management is not working. “The real problem for financial markets is they are being kicked around by outside forces – for example, forced liquidation from hedge funds – which is causing irrational movements. Until we move that out we can’t go back to the longer-term themes. We need to think about the big drivers, the big ideas, rather than the hidden hand. We’ve seen the hedge fund industry implode with liquidations as they seek to get their money back before the end of the financial year, which in the US is the calendar year. I think some sense and sensibility will come next year.”
Within the global bond portfolios at T Rowe Price, Fertat has been reallocating currency risk away from European currencies into dollars. The portfolios are also overweight short maturity government bonds.
“We are starting to see opportunities in the credit space – in investment grade corporate debt in particular,” he says. “We also see opportunities in emerging market debt issued in US dollars. We have seen a correction.”
Fertat says the gradual move back into corporate debt is being replicated across the market, but there will be no aggressive buying yet. “It’s still a waiting game at this point. Everyone is waiting to pull the trigger and increase their allocation to global corporate bonds. But in terms of the market it doesn’t really matter if you miss the first 1 or 2% of a rally.”
“In the International Bond fund we can’t do anything below very high quality,” says Cowley. “But in client portfolios, where they allow, we have been buying corporate bonds on a case-by-case basis. Part of the problem with implementing this strategy, though, is we don’t have a fully functioning corporate bond market. Nothing is really trading – there is no liquidity.”
Tilney Private Wealth Management’s Investment Strategy Group, headed by Peter Bickley, its chief economist, is positive on European and emerging bond markets, although it points out that emerging bonds contain the good, the bad and the ugly; it likes Brazilian bonds but is wary of many Eastern Europeans. It is less bullish on American and British bonds.
Geikie-Cobb has until recently been long of duration assets in Europe and had a long position in the dollar as the unwinding of excesses favoured repatriation into dollars. “Since the end of the calendar quarter we have made some significant switches,” he says. “We’ve pared back our currency position and have cut back on long duration assets. These have been replaced with long gilts and inflation-linked bonds in America, Tips (Treasury Inflation-Protected Securities).” Some 40% of the portfolio is in inflation-linked bonds.
Fertat, too, sees opportunities in the inflation-linked market. “In the short term the market will receive negative inflation, which leads to unattractive income. But in six months’ time there will be more appetite for them,” he says.
One sign to look out for, says Cowley, is when the dollar starts moving down again. “Then you will know we’re getting back into a situation of functioning markets. That’s one of the indicators. That will bring some kind of new equilibrium.”