Article provided by Jeff Green, Head of Fixed Income at Waverton Investment Management Limited, for Beacon Gainer private wealth advisory services group.
2019 was a year of exceptional returns for bond markets. While bond yields drifted lower due to falling inflation expectations and a weaker global economic growth outlook, credit markets also performed well. Yield spreads on corporate bonds moved significantly tighter as markets decided that policy makers would loosen monetary policy sufficiently to avoid any rise in defaults. Indeed companies are still improving their balance sheets by terming out debt at ever lower rates which supports cash flow.
The Waverton Global Strategic Bond Fund (Class A USD) had its best year since its inception in January 2010 with a return of 10.8%. Despite running a conservative (low) duration strategy, the fund still managed to outperform global bond indices and peer groups alike.
That’s the good news but in our last two notes we described our very cautious view for the Gilt market and then of the challenges ahead for the credit markets, both due to the very low level of yields and tight liquidity conditions in the market. The ‘duration effect’ is the impact of changes in yield on price. As yields rise, prices fall and at current levels the sensitivity of prices to yield is much higher than it has been in the past. It means that income gains can be wiped out by price moves from minor changes in yield. During the bull run, investors didn’t pay attention to this when the duration effect was in their favour but when yields rise (which we think they inevitably will) investors will not enjoy the impact on prices. Duration and liquidity are two major tail risks facing us and we think fixed income is no longer a safe asset class. As we move into 2020, we continue to see extraordinary levels of corporate issuance and an investor base which seems to have an insatiable appetite to keep buying these bonds at ever lower yields. Investors appear to be convinced that we are in a cycle of permanently low rates and negative real yields. We caution against this optimism and fear that the more bullishness we see in our markets only increases the pain that might lie ahead.
In our fund, our approach has always been to simply generate a meaningful return ahead of cash – to compensate investors for taking a modest amount of investment risk. Therefore our focus is to preserve our investors’ capital while continuing to collect attractive levels of income. Our portfolio is populated with our highest conviction ideas. We invest in bonds which we think can generate a differential return to bond indices and passively invested bond funds. Predicting the timing of the end of this bond cycle is extremely difficult but we think it is very close, so we have equipped ourselves with the tools to manage scenarios which would damage wealth and are not blindly following the gravy train of ever lower yields. We have the ability to hedge interest rate risk across the major markets (including the ability to run with a short duration stance) and we also invest in low cost options to provide some protection against a sharp sell off in credit markets. We are ready to increase our use of these instruments at the first sign of distress in credit markets.
Fortunately global fixed income is driven by a number of factors and one point of optimism is that we do expect a weaker US Dollar from here which should underpin returns in our favoured currencies including the Mexican Peso, Indonesian Rupiah, Indian Rupee and the Nordic currencies.
Bond markets have sucked in trillions of Dollars in recent years as investors have hunted for yield. Bond markets have enjoyed a glorious bull run for almost 40 years but the concern is that the exit could be disorderly given the scaling back of investment bank trading books. Who will investors sell their bonds to? We think our more absolute return style will help us navigate the next phase of the cycle and help us to keep generating superior returns for our investors.
Risk Warnings: The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.
Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.
Past performance is no guarantee of future results and the value of such investments and their strategies may fall as well as rise. Capital security is not guaranteed
The information relating to ‘yield’ is for indicative purposes only. You should note that yields on investments may fall or rise dependent on the performance of the underlying investment and more specifically the performance of the financial markets. As such, no warranty can be given that the expressed yields will consistently attain such levels over any given period.
Copies of the Waverton Global Strategic Bond Fund Prospectus and Key Investor Information Document (KIID) are available from Waverton. Details can be found on our website: www.waverton.co.uk/investment-funds