Bond market liquidity has become a hot topic in recent months, with some commentators suggesting we are on the cusp of a crisis.
In a Bank of England blog in August, Yuliya Baranova, Louisa Chen and Nicholas Vause from the capital markets division said that dealers, who have been impacted by increased regulation, have cut their fixed income inventories by more than 75 per cent since the 2008 financial crisis “suggesting a significant withdrawal from market making activity”.
However, Nick Hayes, manager of the £311m Axa WF Global Strategic Bonds fund, says it is unlikely liquidity will ever be an issue.
“There has to be a shock for bond market liquidity to be a problem,” he says. “Now that people are so prepared, it may never be a problem at all I suspect.”
Hayes says he is protecting the fund from any potential liquidity problems by owning diversified assets and holding government bonds.
“Even though government bonds are expensive we are holding them, not to make money from them, but for liquidity. If the fund was closed ended we might have a different asset allocation. The liquidity premium is part of our analysis.”
“There has to be a shock for bond market liquidity to be a problem. Now that people are so prepared, it may never be a problem at all I suspect.”
Having said that, Hayes has reduced the fund’s allocation to government bonds this year, from 30 per cent to 15 per cent, and has been moving down the credit curve.
“Earlier this year we took a cautious view on government bonds,” Hayes says. “We concluded that investment grade and high-yield debt, with the exception of emerging market debt, was cheap compared to government bonds, although it was expensive outright. Now we can buy US high yield at a yield of 8 per cent, which is pretty attractive, while triple grade is yielding 4 or 5 per cent.”
During the summer Hayes began rotating out of higher grade assets and into lower grade high yield, notably in the US, which he describes as “particularly attractive.” High yield including emerging markets has moved from 33 per cent to 39 per cent, with the US high-yield allocation rising from 15 per cent to 20 per cent.
“We began too early in the summer, although it is better to be too early than too late,” Hayes says. “We then moved more two weeks ago. October has been good for us so far.”
Although Hayes anticipates a pick up in defaults, especially in the US where high-yielding energy companies will struggle to re-hedge the oil price following its recent decline, he says the market has priced this in.
“In Q2 next year we will see a peak in defaults. We won’t own any defaulting bonds, I hope, but lots of bonds are priced as if they will default. Their yields are anything from 8 to 15 per cent, but if they don’t default then you get your money back.”
Hayes says it has been “a tough year in fixed income,” but adds that the fund has “performed relatively well against its peer group,” which he attributes mainly to its emerging market position. Hayes reduced the fund’s overall exposure to emerging markets from 10 per cent to 3 per cent in July, which he says worked in the fund’s favour due to the greater volatility seen in the markets, although he is now considering upping the allocation again.
“Emerging market high yield is doing very well recently as the oil price has stabilised at $45.50 a barrel, having been $100 12 months ago. If the oil price can really stabilise or even rally, it will be a big supporting influence on US high yield and emerging market assets. We now also need stability in China’s growth and equities.”
Year to date the Axa WF Global Strategic Bonds fund has returned 1.36 per cent against the fall of 0.86 in the IA Global Bonds sector average, FE data shows.
“Reducing our allocation to emerging markets helped. We missed lots of losses, which is as good as making money. We also increased the fund’s duration after the sell off in Q2, which came through in the summer,” he adds.
At the start of the year, the fund’s duration was running at 2.5, but this was increased to 4.25 in June.
“We increased the duration on a more neutral view on government bond yields, but also on a more cautious stance on credit.”
The Axa WF Global Strategic Bonds fund was launched in May 2012 as “a low-cost way for investors to outsource their fixed income exposure”. The fund is not tethered to a benchmark and uses specialist fixed income teams within Axa IM to manage the portfolio’s different allocations.
“It is my fund but I use investment experts in a carve-out structure. I want them to provide a concentrated carve out of their strongest convictions, so they manage a standalone fund of 30 to 40 stocks for my fund. We take a team-based approach but the absolute responsibility lies with the named manager.”
Michael Graham runs the US high yield section of the portfolio, Frank Olszewski manages the US investment grade sub portfolio and Sailesh Lad oversees the emerging markets carve out. Government debt, inflation-linked bonds, sterling and euro investment grade and high-yield debt are under Hayes’ remit.
The total number of holdings in the Axa WF Global Strategic Bonds fund is approximately 230, which Hayes has decreased over the summer due to the increased credit quality of the holdings, but tends to remain broadly consistent.
Hayes, who is head of active UK fixed income at Axa IM, joined the group in June 2010, having spent seven years at New Star, which was later taken over by Henderson Global Investors.
“I joined New Star in 2002 to work with Theo Zemek and James Gledhill as a junior fund manager,” Hayes says. After a nine-month stint at Henderson, following the takeover he joined Zemek who moved to Axa IM in 2008, with James Gledhill following a year later.
Hayes says despite the difficult year he is more bullish on fixed income, selectively, for the coming year.
“We have had a very difficult period in credit that, if it was the equity market, would have been more widely reported as a nasty correction or a bear market.
“With our economic outlook still fairly benign, gently positive global growth and accommodative central bank policy, I can get quite bullish on parts of credit and high yield, in particular US high yield and some parts of sterling and euro investment grade.
“Given the recent correction it is entirely possible that we will see higher government bond yields without it causing wider negative implications in other asset classes, as we saw in May 2013 with the ‘taper tantrum’.”
2010 – Joins Axa IM as senior portfolio manager
2012 – Launches the Axa WF Global Strategic Bonds fund
2014 – Promoted to head of active UK fixed income and flexible global strategies