Andrew Wilson, CEO of GSMA EMEA and global co-head of Fixed Income, says a flexible approach to the bond market is required.
Your strategy is reminiscent to total return approaches. What are the similarities and what are the differences?
We are definitely focused on the total return rather than the relative return versus a benchmark, but we think our strategy differs from traditional “total return” approaches to the bond market in a couple of important ways.
First, a traditional total return bond strategy will be long interest rate risk across all environments; it’s simply a matter of how long. Our strategy can move to a short position in interest rate risk.
Second, most total return strategies have limited flexibility to look across traditional market divides. A total return strategy focused on domestic bonds will generally have very limited flexibility to diversify into foreign developed bonds, and even a global strategy will have limited flexibility to invest in emerging market bonds. Our strategy does not have these limitations. We can look across developed and emerging markets, and across domestic and global sectors of the bond market, to find the most attractive risk-adjusted return potential.
With such a strategy – what kind of annual returns can an internationally oriented bond fund investor expect currently?
Over the last several years we have generated total returns in the area of 5.5% to 6%, with volatility of less than 4%. We think the global bond markets offer plenty of opportunities today, but past performance is no guarantee of future returns, of course, so future returns may vary.
Do you go in riskier assets such as High Yields to reach your target returns?
No investment strategy can generate returns without taking risk. In our view, the question is which risks offer the most attractive compensation. When we think high yield is attractive, we will definitely move into that sector of the market. In fact, we think risk-adjusted return potential is much more attractive in high yield compared to government bonds, where you earn very little yield for the risk you are taking by being exposed to interest rate risk. We can also use hedging strategies to isolate high yield risk from other risks such as duration, which we think can significantly improve the risk-adjusted return potential of non-government bond sectors.
Which segments of the international bond markets you currently like? And vice versa: What are the greatest risks for bond investors?
We see value in some European markets and in some emerging market countries. With the rise in US rates, we’ve seen investors move out of interest rate risk globally, leading to higher rates in many markets. However, some countries have very different fundamentals compared to the US and we do not think higher rates make sense in some of these cases. In Germany, for example, 10-year rates have risen sharply but the eurozone only recently emerged from an 18-month recession and the European Central Bank is still talking about easing. In the US, growth is stronger and the Federal Reserve is talking about tapering. The point in our view is to be flexible and take risk fluidly, where it makes sense, not where a benchmark dictates.
Regarding Europe: How do you judge the chances of the euro-bond markets after Germany has elected? How do you position yourself in the euro area, and what trends do you see in the currencies, so the euro-dollar relationship?
We see progress in the eurozone’s efforts to move toward more sustainable growth and borrowing models. However, this is a challenging process and we think some of those challenges were put on the back burner ahead of Germany’s election and could now move back to the front burner. We think that prospect raises the potential for more volatility than we have seen recently and will keep the pressure on the European Central Bank to maintain low rates in the face of rising US rates. Based on that view, we are generally positive on German government bonds versus those in peripheral, highly-indebted countries like Spain.
We are cautious on the euro given the strength in the currency and the effect that could have on exports and growth. We think this is something the ECB is keeping an eye on and that makes us cautious.
In the US, meanwhile, the budget dispute boils up again – a burden for the bond markets?
The budget disputes in the US could actually be more positive than negative for the bond market. We do not think policymakers will push the current dispute to the point where even a short-term default becomes a serious risk. However, we think uncertainty over fiscal policy will continue to weigh on consumer and business confidence. That could restrain the recovery. It could also benefit bonds in a couple of ways. First, a modest recovery would ease some of the upward pressure on rates. Second, cautious businesses would be less willing to add leverage to their balance sheet, which would be positive for the credit quality of the corporate bond sector. Finally, fiscal disputes tend to make investors more cautious, favoring the bond market over equities.