Few issues have been as hotly debated among investment commentators this year as the direction of interest rates. But Old Mutual Global Investors’ Russ Oxley is less preoccupied with which way rates will go and more concerned with the market’s expectations.
Oxley is lead manager of the Old Mutual Absolute Return Government Bond fund, which launched in October last year. Essentially a forward rates fund, Oxley can take long or short positions in government bonds and uses derivatives in interest rates, inflation and currencies to create a non-directional portfolio. The fund aims to deliver overnight cash plus 4 to 6 per cent on an annual basis with a low correlation to the bond and equity markets.
Oxley explains: “The fund’s process is based on what the market thinks will happen, not what will happen. It is based on how the market reacts to incoming data. Our performance is not predicated on predicting the market correctly, but on the set of stimulus and understanding there are different forces at work.”
The Absolute Return Government Bond fund is Oxley’s brainchild. He developed the forward rates process when he was head of rates at Resolution to enable him to manage a number of different fixed income portfolios with different benchmarks.
“Necessity is the mother of invention,” he says. “To manage all of the portfolios consistently from a rates and macro point of view, I had to throw away the textbook.”
Oxley, now head of rates and liability driven investments at OMGI, has been a fund manager for 19 years. Having studied chemistry and management at Imperial College London, he thought his science background was better suited to the fixed income world rather than equities and joined Guinness Flight Hambro (now Investec Asset Management) as a trainee gilts manager in 1997.
In 2000 Oxley left to join LV Group as a fixed income manager, followed by a stint at Swiss Re, where he managed pension and life money, predominantly sterling and global government bonds. In 2004 Oxley joined Britannic, taking the opportunity to become lead fund manager on the UK government bond fund. In hindsight, Oxley says, this turned out to be a well planned move, as when Resolution took over Britannic in 2005, Oxley saw the assets he was managing swell considerably, jumping from £3bn to £10bn. When Resolution went on to merge with Pearl Group in 2008 (with the asset management arm subsequently rebranded as Ignis Asset Management) those assets leaped to £20bn.
Meanwhile, Oxley had been developing his process of using forward interest rates more effectively, hiring current co-managers Adam Purzitsky and Paul Shanta to assist him in developing the concept.
Oxley says: “The traditional way of managing a bond portfolio is to look at the duration and the curvature. It had served fund managers well for a number of years. But with the different maturities of benchmarks in many different portfolios, it became apparent that this was not a sufficiently accurate way of managing risk.
“The market price for bonds in the near term badly correlated with the prices for the distant future. I realised that forward rates don’t move in parallel at all. It was quite a pleasing observation; it was logical. Why would the market price in the near-term change in monetary policy in 20 years’ time?”
Oxley continues: “We threw out the existing tools and systems and built our own from scratch. If you want to be at the frontier of a subject you have to build the infrastructure. We don’t aggregate years on the curve together and look at the net, we look at what is priced in for each non-overlapping year. We move away from prices and yields and look at what the market is expecting, then we work out how we are exposed to those expectations.”
The fund’s philosophy is based on the forward rates curve being influenced by different factors. In the short-term, forward rates are influenced by monetary policy and the market’s expectations of monetary policy, while over the medium term interest rates are impacted by the funding needs of nations and economies. Over the long term, rates are influenced by the hedging of pension schemes and insurance companies, regulation and the sovereign bond issuance.
The fund’s process entails forming an overarching macro view, which in turn generates four or five major themes, which are each exploited through four to five exposures, one of which will have an “offsetting role”.
Oxley says the forward rates process was “very successful” at Resolution and he realised that if he could find a way of running the risk in his portfolios in a more efficient way, it could have implications for standard portfolio management. “We made lots of alpha in 2007, 2008 and 2009. It was clear that what we had discovered could be applied to an absolute return fund,” he says.
In 2011, Oxley, who by then was head of rates at Ignis, launched the Ignis Absolute Return Government Bond fund. The fund’s non-directional nature proved popular, raising $6bn (£4.5bn) in three years.
“The fund was received very well. We made 6 per cent net of fees annualised over the first three years. We had discovered a way of taking a huge liquid market of currency, government bonds and rates and extracted alpha in a way that was respectable and sustainable.
“People can upgrade from investing in a traditional government bond fund. We still concentrate on a safe asset, default-free universe, but we remove the directional nature, the exposure to rates going up or down.”
In March 2014 Ignis was sold to Standard Life, with the deal completing in June 2014. During the takeover OMGI recognised the opportunity to get Oxley and his process on board. Oxley says: “Our product was consistent with OMGI’s experience in the liquid alternative space. They already had a successful product in [the Global Equity Absolute Return fund], and their vision was similar to ours.
“There is no set OMGI process; it is individual or team led. Our flavour of the liquid alternative space is a consistent vision.”
Oxley joined OMGI in April 2015, with the Absolute Return Government Bond fund launching in October 2015. The fund was seeded with £100m and is already at £450m.
Since launch, the fund has lost 3.9 per cent against the 0.4 per cent fall in the IA Targeted Absolute Return sector, according to FE data. “The fund started reasonably well,” Oxley says. “This year there has been a sudden change in the interest rate profile, which hurt the fund. It felt like a violent reassessment of the recovery that was probably not justified.
“The portfolio is positioned to do well when the market expects rates to normalise to a degree. There is not much priced in for US or UK rates going up, but that is not correct, they will go up in the next couple of years. The market will become convinced of that. We are therefore short of the front end. Monetary policy is normalising, but we are not positioned for a complete return to normal.”
Oxley predicts US rates will rise 1.25 per cent this year and go up 1 per cent next year. He says UK interest rates will go up 75 basis points by the middle of next year, with rises beginning towards the end of this year.
“We don’t expect a sudden return to higher interest rates – they will remain relatively contained.”
1997 Oxley joins Guinness Flight Hambro (now Investec Asset Management) as a trainee gilts manager
March 2011 Oxley launches the Ignis Absolute Return Government Bond fund
April 2015 Oxley joins OMGI as head of fixed income absolute return
October 2015 The Old Mutual Absolute Return Government Bond fund launches