Dan Siluk, co-manager of the Janus Henderson Absolute Return Income Fund, covers a number of topics on fixed income markets, including questions about Australia, BBB and curve positioning.
What would you describe as the biggest threat and biggest opportunity for fixed income?
One of the biggest threats that we are seeing today in fixed income is the swelling of deficits in the US. So the strong fiscal policy of the current US administration is resulting in the Treasury having to issue more debt. More debt comes with higher yields. Also you have the European Central Bank (ECB) winding down quantitative easing towards the end of this year and looking to raise rates into 2019. The Bank of Japan has also for the last two years has been decreasing the size of its QE programme. So we are looking at rising rates acting as a potential threat to fixed income markets.
The opportunity for us is that we are an absolute return income focused manager that is benchmark agnostic, which means we do not need to own duration. In fact, we can take duration risk or interest rate risk from other jurisdictions around the globe.
So we look at places like Australia and New Zealand as opportunities, where central banks are dovish. They may not be cutting rates necessarily but they are certainly on hold for an extended period of time. So we prefer to have exposure in those sorts of nations.
Australia: Why are you favouring Australian duration (interest rate sensitivity) relative to the US?
Today we are favouring Australian duration over US duration for a number of reasons. Economic growth in Australia is quite slow. Household debt to income is at high levels. The banks are facing increased funding costs.
So what we have seen is a couple of the Australian banks have actually increased their mortgage rates. And that precludes the Reserve Bank of Australia (RBA) from having to cut rates aggressively. They are happy to keep rates on hold, the RBA is dovish as opposed to the US where the US Federal Reserve is raising rates and unwinding its balance sheet. We see Australia as a place to hide in terms of interest rate risk and duration exposure.
BBB: Should we be worried by a growing BBB market?
We are not generally worried about the size of the BBB market and the fact that it is growing. In fact there are some good reasons for the growth in BBB rated assets.
One of those is the fact that one sector, in particular – US autos – has seen upgrades this cycle. So the likes of Ford, General Motors, over the last five to six years, have been upgraded from high yield to investment grade status.
Another reason we are not too concerned is that the rating agencies post-crisis have applied more conservatism in terms of the way that they rate the banks. So a single A rated bank pre-crisis is now rated BBB. We do not believe that that results in increased risk. In fact, a BBB rated bank today post-crisis is probably safer than a single A rated bank pre-crisis.
Another reason that you have seen an explosion in BBB rated assets is due to merger and acquisition (M&A) related activity. That M&A activity tends to be focused in three main sectors in recent years: being oil and gas, telecom and healthcare.
Curve: Which area of the yield curve are you currently favouring?
The part of the yield curve that we are favouring today is actually the front end in the US. We like the 2-year part of the curve for the steepness and the roll down that it provides.
The front end of the curve today in the US is quite steep from the 2 year to the one year point. It is worth about 20 basis points in roll down. If you compare that to the 2-year and 10-year part of the curve the steepness is also worth just over 20 basis points so you are not getting paid to take that additional duration risk.
We like the front end of the curve despite the fact that the Fed is raising rates. We believe there is a significant cushion or buffer. So you need to see a significant unexpected rise in rates of about 130 or 140 basis points in order for your coupon on a 2-year Treasury to be wiped out, as opposed to only 20 to 30 basis points on the 10-year Treasury. So we like the 2-year part of the curve.
Video fimed on 20 September 2018