With Europe characterised by negative rates and subdued bond yields, Nick Maroutsos, Co-Manager of the Absolute Return Income strategy, explains how the team seeks to meet the objectives of an absolute return fixed income portfolio.
Avoiding a home-country bias to investing widens the investment opportunity set and can help to uncover attractive risk-adjusted opportunities overseas that can potentially offer higher yields after currency hedging costs.
The team’s investment ideas are driven initially by macro determinants, particularly the direction of interest rates, which we anticipate to be supportive in 2020 as central banks remain in accommodative mode.
At a sector level, we favour financials, particularly bonds issued by monopolistic-type entities in Singapore and Hong Kong and the major banks in the US.
Do negative rates in Europe present a challenge for investors?
There are many ways that we can stay positive in a negative interest rate environment. The first case, I think the best case, is that we just avoid negative interest rate debt. To us, I think it sort of flies in the face of every textbook that we’ve read. Now it doesn't mean that negative interest rate debt or negative-yielding debt can't move more negative. The feeling is that there are better opportunities that are out there, whether it's looking at a variety different sectors or a variety of different countries for investment opportunities and looking to hedge those back to the base currencies in ways that you can still achieve positive returns in a low interest rate environment.
Is it important to avoid a home-country bias when investing?
Our belief is that you do not need to adopt a home-country bias when it comes to investing in debt. I believe that there are numerous opportunities that exist around the world whether it be in a variety of different countries or sectors. So when populating or investing in a euro-based portfolio you don't have to own only European assets. You can own European issuers in other currencies or you can try to find proxies for those assets and identify sectors that are attractive in other regions that still spin off positive income and positive yields.
How does an idea first come to you?
Given our open mandate ideas come more on the macro level to start with. We take a very long-term view of the market but then we ultimately filter that down to what we expect is going to happen in markets over the next six to 12 months. It's a function of interest rates globally. It's a function of central bank policy, employment and other economic data that ultimately leads us to where we want to be positioned on a duration perspective as well as on a credit perspective. So from that point we ultimately filter down the universe to a much more micro level where we are able to identify what we believe to be the best risk-adjusted opportunities.
Where are you finding opportunities and risks?
We are typically very optimistic about 2020 and the investment opportunities that are around; largely because of the US Federal Reserve (Fed) and other central banks looking to backstop markets and provide the liquidity and ultimately keep the party going but also because we're also faced with an environment where rates are likely to continue to move lower. So therefore we are looking for the best opportunities in countries where rates are going to be moving lower but also in countries and in sectors where credit spreads are priced for the best return potential. And our belief is that is in monopolistic-type entities and in Australia as well as various opportunities in the US corporate debt markets.
Some of the large risks that we see also pertain to the credit space so it's not a matter of just blindly buying credit and riding the credit wave because valuations in credit are very rich. It doesn't mean that there's not value to be had there. But ultimately we believe that investors need to be a lot more realistic about the asset that they're buying and the value of the asset that they're buying.
Are there areas that you particularly like?
One of the key sectors that we like is financials so we tend to be a large owner of Australian financials as well as monopolistic type entities in Singapore, Hong Kong, etc. Furthermore, we like the US financial markets, particularly the major deposit-taking institutions or the “Too Big to Fail” type banks in the US. Some of the asset classes that we don't like within the credit sector are energy and autos which don't make up a large portion of our portfolios. We think that given the economic backdrop, particularly as the economy leads to more of a slowdown for 2020, those assets will likely underperform over the next 12 months.
What is focusing your mind in early 2020?
One of the long-term indicators that we tend to focus on year in year out is the path of interest rates. What are central bank expectations for a year for a particular country? But also what's priced into the market in terms of the directionality of interest rates over the course of that year? That tends to be a focus because ultimately, as bond investors, we need to take a view either for or against that in order to outperform the market. More near term some of the issues that we're looking at for 2020 centre around the US election, the trade tensions between the US and China, as well as Fed policy because ultimately we believe that Fed policy is going to be one of the things that dictates future policy for other central banks for 2020.
Why should investors consider absolute return income?
In our view, the rationale for owning absolute return income over other asset classes within the fixed income landscape is very simple and that is that we start with a clean sheet of paper. We are benchmark-agnostic meaning that we look to identify the best risk-adjusted opportunity for the level of risk that we're taking. Ultimately trying to achieve a positive return regardless of what the market is doing but still trying to maintain the same key characteristics of traditional fixed income: those being capital protection, income generation, low levels of volatility, and diversification. Similarly, absolute return income can fall within numerous buckets within the fixed income class. It doesn't actually fall in one particular bucket. The first is that we aim to enhance cash and by accepting a modest amount of more volatility we can look to achieve a higher return than what your investors are getting in the cash portfolios. Secondly we can serve as a complement to core fixed income. Typically, core fixed income has much longer duration than we have had historically and in an environment where there is a lot of uncertainty around the path of interest rates we can serve as a risk mitigator against that core portfolio.
Notes Duration: A measure of the sensitivity of a fixed income security or portfolio to a change in interest rates. It is expressed as a number of years. The larger the figure, the more sensitive it is to a movement in interest rates.
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