Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by AXA Bond Fund Manager, Nicolas Trindade.
Hello, Nicolas.
Nicolas Trindade: Good morning.
Wall: So, a bit of lengthy title, your fund, AXA Sterling Credit Short Duration Bond Fund. I thought we could pick it apart piece-by-piece starting with Sterling. A lot of equity investors at the moment who invest in sterling are seeing an implication from our currency being significantly devalued. Is that the same for bond investors?
Trindade: Well, the thing is that in our Sterling Credit Short Duration Bond Fund we fully hedge currency risk. So, we do invest in non-sterling-denominated bonds, but we hedge for currency risk which means that we don't have any currency risk within the portfolio. But then obviously, a lower pound can have an impact, particularly it can have an impact on inflation.
And what we expect is we expect to see higher inflation on the back of a lower pound. And obviously, if you have a high inflation that could lead to higher yields and that's why having a short duration emphasis within the portfolio is quite attractive because that gives us the ability to benefit from higher yields because of higher inflation.
Wall: And short duration bonds are those with shorter terms. I mean, people think about this in terms of mortgage. You fix your mortgage for 5, 10 years and that's good when you are a borrower because you want rates to remain low for as long as possible. But potentially, with bonds yields moving around so much at the moment, short duration is a real positive?
Trindade: Yes, definitely, because when – I mean we define short duration as bonds with less than five years' maturity. And when you invest in a short duration bond fund, you lower your duration risk, you lower your credit risk and you lower your liquidity risk. And we think that in this environment where we have a big disconnect between fundamentals and valuations and while there are a lot of risks going into the end of the year, the U.S. election, the Italian constitutional referendum, the federal decision and obviously more noise around Brexit, there is a strong case to actually de-risk your fixed income allocation and move to a shorter-duration bond fund that will have you lower all those risks.
Wall: Of course, at the very beginning of this year no one thought Brexit was going to happen. So, if you had said at the beginning of this year where you expected Bank of England to move bond yields, you would have thought they would be putting the interest rate up. But they haven't; they have cut it and they have also introduced fresh rounds of quantitative easing with perhaps more stimulus to come. How does that affect the way that you run a bond fund?
Trindade: Well, to be honest, the announcement of corporate quantitative easing actually came as a surprise to us and I think came as a surprise to the market. We're not expecting the Bank of England to announce a 10 billion program to purchase corporate bonds and that had a tremendous impact on the market and what it's done is basically further distorted prices in the fixed income market and further increased the divergence that we have between fundamentals on one side and valuations on the other side.
And the market has performed really well this year despite Brexit and that's why we are quite cautious and we haven't been keen on chasing the rally because we're just really worried about the valuation at this point in time. And in the portfolio, that I manage, for example, we've been more – everything on the cautious side and we've been actually increasing the cash balance and investing most of the money in defensive sectors because we think there is going to be a repricing at some point and we want to make sure that we are in a position that we can benefit from it.
Wall: And you said there is going to be a correction in the market, a repricing in the market. Obviously, bond yields have been very low for a long time. That means prices, of course, are rising which is great in total return point of view. Where do you foresee a return to normality? Is it next year? Is it the year after? Or is it much further out than that?
Trindade: I think it's going to take a couple of years before we can get back to normality. But in the meantime, what you may see is a lot of volatility and October is a very good example. If you look at the yield on the 10-year gilt, it went up by 40 basis points. It's a big move. Now, the yield of the 10-year gilt is back above 1%. At the lowest, in mid-August, it was at 50 basis points. So, we've seen a big move. That means big negative total returns for the average corporate bond fund because the average corporate bond fund will have a duration of about nine years, so very high sensitivity to rising yields. It can be a really big issue for some investors.
And that's why in this environment where we expect volatility to stay quite high, I think there's quite a strong case basically to look at de-risking your fixed income allocation, because a lot of investors would have done really well year-to-date, I mean double-digit returns year-to-date, and I think it's very dangerous to be too greedy and try to look for the next percentage point of returns when you've done really so well and where there's so risks ahead.
Wall: Nicolas, thank you very much.
Trindade: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
