Q: How is the portfolio positioned and what changes have you made?
A: We have been following three major strategies. Firstly, we have been positioning for a global recession where global growth is close to 2%. We are positioned for more countries to cut interest rates – not the UK, US and Japan but other markets with higher yields.
Secondly, we are positioning ourselves for Asian currencies to appreciate against the euro, the pound and the dollar. This is largely because Asian growth is likely to outperform developed market growth.
Even though it will be slower, growth will be higher than in the US and UK. Asia runs very large surpluses so it is a large net creditor for the world. Creditors tend to do better in periods of deleveraging as borrowers are paying off their debts, which benefits lenders.
Thirdly, we have been taking advantage of investment grade and sub investment grade credit. Spreads in emerging markets are wider than they were in the 1998 crisis but countries are not facing the same risk.
There is no question liquidity and growth are weakening, but fiscal and economic reforms have put countries in a better position. This strategy is an opportunistic part of the portfolio. The average credit quality of our corporate bonds holdings is A.
Q: Will the largest creditors be at a greater risk from defaults?
A: There is not increased risk of default because most of the lending has been in government bonds, which are high quality. China for example is less exposed to subprime because most of its lending to the US has been government bonds.
Q: What impact has the credit crisis had on fixed income as an asset class?
A: It has been a great stress test for global bonds. The fund is still positive, up about 2% year to date. Diversification has been key to performance – we are invested over many different countries and currencies. This credit crisis has shown us that global bonds can be a good complement to domestic equities because the two asset classes work in completely different ways.
Q: How much liquidity is there in global bond markets at the moment?
A: Liquidity as a buyer is excellent, as a seller it is not so good. We have been buying good fundamental positions at distressed levels. Liquidity in government bond markets has been much better. We have had no material problems with liquidity as we have been opportunistic buyers.
Q: What is your outlook for the asset class?
A: My outlook is pretty good. Most countries will have to cut interest rates as the crisis deepens. The opportunity for additional interest rate cuts is outside the G3 and G4 countries. Rate cuts have mostly been priced in in developed economies. In South-East Asia or Latin America there is close to a 20% yield in many cases. There is a lot of potential upside in these markets when we have come through the worst of the credit crunch and into recession.
Q: How do you play currencies within the Global Bond fund?
A: We separate our currency and interest rate decisions. In New Zealand, for example, we like long duration bonds but we hedge all the currency risk. We have our biggest currency positions in Japan without any exposure to the the bond markets. We have 40% in the Japanese yen and 0% in government bonds. We will either play through currency funds or government bonds depending on the situation.
Q: What is your view on Asian currencies?
A: In the medium term I think they have overshot, looking at the valuations. They are trading at levels we have not seen since the Asian crisis, but this is due to panic and forced selling. However, these countries have good debt dynamics and relatively good growth so they should outperform.
Iceland for example has a weak currency because it has macro imbalances. Malaysia does not have these imbalances but still has low valuations, which are not consistent with the fundamentals of the country. This is an overreaction of markets relative to the fundamentals.
We are through the worst of the financial crisis but we are at the beginning phases of the economic slowdown. Volatility will continue for the next couple of quarters but volatility is a good thing for us as it means we can access distressed assets. The volatility of my fund year to date is 5% or 6%.
Investors need to have a two to three-year horizon as it will be hard to navigate through this period.
Q: Which single holding has been the best contributor to performance on the fund over the past 12 months?
A: Being short the euro and long the US dollar and Asian currencies has been good for us. We went long a basket of Asian currencies from countries including Malaysia, China, Taiwan and Singapore. We thought the euro was overvalued because the market recognised that the problems Europe was experiencing were equivalent to those in the US.
Six or nine months ago the market thought Europe was decoupled from the US but this was a false view. Moves by the European Central Bank to cut interest rates were a reality check and showed that the region had many of the same imbalances as the US.
Q: Are you finding increasing issuance from governments despite the credit crunch? How could this affect global currencies?
A: I am not finding a lot. Most countries have the fiscal resources to spend without having to issue lots of debt. But we will see much more issuance as governments begin to spend more. The US will have to come close to doubling its indebtedness while the UK’s borrowing could be 8% of GDP. There will be a tremendous increase in issuance, which could easily have an impact on currencies.
The dollar will now share the role of reserve currency with Asian currencies. As the market reacts to the cost of the crisis we will see issuance on the back of that.
This will cause pressure on currencies, which is why we like Asian currencies so much. The pound will be under pressure following the planned government borrowing, and we have zero exposure to the UK as a result.