Ollie Smith: Bond, bonds, bonds – this year, they really have looked like the problem child of investing, but there are pockets of outperformance worth looking at. Here to explain more is senior manager research analyst for fixed income Evangelia Gkeka.
Evangelia, why has this market been so troublesome year-to-date?
Evangelia Gkeka: That's true. It has been troublesome this year. So, so far this year, we've seen fixed income markets experiencing significant volatility and recording one of the most aggressive sell-offs in the last decades. At the beginning of the year, markets were surprised by the Fed's indication to raise rates aggressively and for the first time since 2018, to tackle high inflation. In response to that, yields moved higher across fixed income sectors and maturities globally.
Another factor, I would say, that impacted fixed income negatively was the escalation in geopolitical tensions between Russia and the Ukraine and the invasion of Ukraine in February, and then subsequently, the heavy economic sanctions on Russia, and sharp rally in commodity prices further exacerbated global inflationary concerns and created fears over economic slowdown and potentially a global recession. We saw multi-decade record inflation numbers, and the government bond yields rose sharply across the board, while investment grade and high yield spreads widened significantly as well. As a result, fixed income strategies and indices recorded large negative returns, in some cases, the largest drawdowns ever.
One important factor that has negatively impacted performance is that in this correction the inverse correlation between safe haven and high-quality government on one side and the risk assets such as high yield and investment grade on the other side, broke down. In previous corrections, such as in 2008 and in Q1 2020, government bonds provided a nice counterbalance for the losses in spread sectors. However, year-to-date, given that we are in monetary tightening cycle, both government bonds and corporate bonds recorded sharp losses. That said, there have been some bright spots in our universe of rated managers, who although recorded negative returns, managed to outperform the category benchmarks. And specifically, I would like to discuss two strategies within our global flexible bond peer group that outperformed their benchmarks.
OS: Sure. So, let's start with the first of those. What does that look like?
EG: Sure. So, the first one I would like to discuss is the Bronze-rated JPMorgan Global Bond Opportunities. The strategy is co-managed by Global Fixed Income CIO, Bob Michele and International Fixed Income CIO, Iain Stealey, while since 2020, three senior PMs focusing investment grade, credit, high yield, and securitised have been added to the roster. So, the strategy aims to maximise total return with 5% to 10% volatility target, which allows the team considerable flexibility investing in variety of sectors such as high yield, investment grade, corporates, emerging markets and securitised debt. Macro decisions are the dominant driver of the process.
So, year-to-date, as of the end of October, the fund recorded negative performance, but has, as I said before, outperformed its Morningstar category index, the Bloomberg Global-Aggregate Index. One driver of the strategy's outperformance has been its short government bond duration positioning, mainly by US Treasury futures in expectation of higher interest rates. Initially, the short positioning was outright at the longer end of the curve given the strong global growth environment. But later in the year, as it became clear that the central banks will have to be more aggressive in hiking rates, the interest rate hedge was implemented with a curve flattening bias. Another factor, I would say, that has helped was the decision to increase the overall credit quality of the portfolio, reducing high yield exposure in expectation of further spread widening and rotating towards high-quality, investment grade credit.
OS: And on the second strategy, what differs there?
EG: Okay. Yes, sure. The second fund I would like to discuss is the Silver-rated M&G Global Macro Bond. This is managed since inception by Jim Leaviss, M&G's CIO of Public Fixed Income. This is a flexible top-down driven strategy that can take long or short positions, including through derivatives, so across the global fixed income and currency markets. And its duration can range from negative 3 years to positive 10 years. So, this flexibility can be used to create a portfolio of long-term valuation-driven themes diversified across rates, credit, inflation and currency markets while actively trading around them based on his view of short-term market technicals.
So, year-to-date, as of the end of October, the fund recorded negative performance but comfortably outperformed its Morningstar category index, the Bloomberg Global Aggregate Index. So, early in the year, the strategy benefited from its underweight duration positioning, and it shorts using CDX indices in investment grade, high yield and emerging markets. Also, the US dollar exposure also helped, as it performed strongly so far this year. And I would say the last – another driver of outperformance was the fact that the strategy entered the period of UK market turmoil in September, so after the mini budget announcement, with a low exposure to UK assets and opportunistically, took advantage of the sell-off and bought long-term yields benefiting from the subsequent market rebound.
OS: What a stroke of luck. Thanks so much, Evangelia. For more on fixed income and indeed the UK's bond outlook, stay tuned for our Special Report Week on 2023 that's happening in two weeks' time. Until then, I've been Ollie Smith for Morningstar.
