GLG bond managers cut duration to avoid becoming a ‘hostage to volatility

Jon Mawby and Steve Roth, co-managers of the GLG Strategic Bond Fund, have significantly increased the portfolio’s exposure to floating rate notes (FRNs) and credit default swaps (CDSs) as part of a tactical move to allocate away from duration sensitive securities.

Mawby became manager of the $191 million fund in October after joining GLG, the investment management division of Man Group plc, from European Credit Management Limited.

The fund’s interest rate insensitive exposure is currently around 40% of NAV, a stance the team held through the second half of 2012.Now Mawby says: “One of our themes at the moment is allocating away from duration sensitive products and replacing them with securities like FRNs and CDSs which do not have a direct correlation with the interest rate cycle.”

“If we get a rise in rates, it is important there is a form of tail risk hedge within the portfolio that allows the fund not to be held hostage to interest rate volatility. Non-interest rate sensitive products provide a degree of immunisation to a sell off in government yields while giving us the flexibility to allocate to the asset classes which offer the best risk-adjusted returns.”

Ensuring that protection is particularly important as stimulus measures becoming increasingly ineffectual. “The margin for error within fixed rate product is getting smaller with each passing round of quantitative easing or central bank intervention,” Mawby explains.

“With breakevens becoming further asymmetrically skewed against investors in fixed rate product we are seeking to take advantage of low cost strategies at a fund and asset class level that allow us a margin of safety in the event that markets normalise or inflation and growth expectations begin to pick up.”

The aim is to exploit risk adjusted opportunities to produce an attractive yield and significantly less cyclical volatility than a standard fixed interest rate product.

With liquidity having plunged across markets, Mawby and Roth are also currently focusing on ensuring the fund remains on the right side of trends across the fixed income universe.

“Liquidity across the board – be it equities, foreign exchange, or credit and bonds – has fallen off a cliff as banks have deleveraged and retrenched from proprietary trading,” Mawby says.

“That makes it essential we stay on the right side of trends and use the market to generate liquidity for us, especially in higher beta instruments. Very simplistically, that means having the discipline to use a rallying market to reduce risk and hence having the flexibility to be able to add risk when the return side of the equation is skewed in the fund’s favour. Avoiding being caught too long at the end of a rally is absolutely crucial right now, particularly in something like European peripheral debt and financials, because finding bid side liquidity in higher beta assets at times when the market is in risk off mode is next to impossible.”

The managers have reduced the fund’s peripheral Europe exposure to around 5% from 15% into the end of 2012 on their view that risks were becoming skewed against the fund. In terms of positioning across the wider universe, Mawby says the pair is trading very tactically, exiting positions quickly where they no longer see value.

“If something trades through fair value we have to be disciplined and take profits, getting too greedy puts the fund in a tactically weak position – something we seek to avoid,” he says. “Our cash balance fluctuates quite significantly – it was as high as 15% at one point – because we recycle investment opportunities into cash when we no longer see value and only reinvest when we find new issues or secondary market opportunities that match both our technical and fundamental requirements.”

In general, Mawby says the pair will continue to asset allocate very dynamically to ensure the symmetry of risk is skewed in favour of the fund. “If we didn’t do that – and it’s been a criticism of strategic bond funds that they don’t asset allocate actively enough – then we couldn’t expect to produce a positive return across the cycle,” he says.

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