Last updated: 08:58 / Tuesday, 26 January 2016
Interview with Jupiter

"Longer Term, The Ability of Central Bankers to Normalise Policy Is Constrained by Powerful Deflationary Forces"

"Longer Term, The Ability of Central Bankers to Normalise Policy Is Constrained by Powerful Deflationary Forces"

Ariel Bezalel, fund manager of Jupiter Dynamic Bond Fund, explains in this interview with Funds Society the opportunities he sees in the Fixed Income space.

In the current low yield scenario and bearing in mind the US rates hikes we are starting to see, do you believe fixed income still offers value?

We do not believe that the US Federal Reserve will hike rates aggressively this year. Nevertheless, our portfolio is defensively positioned and our allocation to high yield is the lowest it has been in a while. We see pockets of value in fixed income.

Are there more risks than opportunities in the bonds markets?

Policy mistakes by the US Fed, a China hard-landing and the broader emerging markets’ crisis are some of the risks in the bond markets at the moment. Opportunities persist and one of our top picks at the moment is local currency Indian sovereign bonds.

Is it harder than ever to be a fixed income manager?

We may be in a more challenging environment for bonds but the advantage of a strategic bond fund like ours is that we can move in and out of different fixed-income asset classes, helping us to steer clear of riskier areas.

Some managers in charge of mixed funds used to see the fixed income as a source of protection and returns. Do you believe that this asset plays now a much more limited role?

Fixed income can still provide protection for investors – default rates are far from recent highs.

Where can you find investment opportunities in fixed income right now (high yield, investment grade, public, private, senior loans…)? Any particular market or sector?

We are running a bar-bell strategy in the funds - in which we have a large allocation to low risk, highly rated government bonds and a balancing exposure to select higher-yielding opportunities. We like legacy bank capital and pub securitizations within the UK. Within EM, we like local currency Indian sovereign bonds, Russian hard currency corporate debt and Cypriot government bonds.

What is going to be the effect of the US interest rates hike we saw last week? Which will be the next steps of the Fed in 2016?  Will we see a decoupling between the US and the European yields?

It will be several months before we can assess the impact of the Fed’s move on the US economy. However, a number of leading indicators suggest to us that the US economic recovery is less secure than is commonly believed. The Evercore ISI Company Surveys, a weekly sentiment gauge of American companies, has weakened this year and is currently hovering around 45, suggesting steady but not spectacular levels of output. The Atlanta Fed’s ‘nowcast’ model indicates underlying economic growth of 1.9% on an annualised basis in the fourth quarter, a level consistent with what many believe is a ‘new normal’ rate of US growth of between 1.5% and 2%.

More worryingly, the slowdown in global trade now appears to be affecting US manufacturing. The global economy is suffering from acute oversupply, not just in commodities but across a range of sectors, and industrial output in the US is now starting to roll over. In this climate, there is a genuine risk that the Fed will end up doing ‘one and done’. In some ways, it seems that the Fed is looking to atone for its failure to begin normalizing monetary policy earlier in the cycle, before the imbalances in the global financial system became so pronounced.

Longer term, the ability of central bankers to normalise policy is constrained by powerful deflationary forces, including aging demographics, high debt levels and the impact of disruptive technology and robotics, a reason why we are comfortable maintaining an above- consensus duration of over 5 years.

What are the forecasts for the emerging debt in 2016? Do you see a positive outlook for the bonds of any emerging country?

We have adopted a cautious stance towards emerging markets (EMs) recently at a time when many developing countries have been experiencing economic and financial headwinds. Currencies and bond markets in countries such as Brazil, Turkey and South Africa have been uncomfortable places for investors to be over the past 12 months as the strengthening US dollar, lower commodities prices and high dollar debt burdens have proved to be a toxic combination.

We have benefited though from situations where indiscriminate selling has left opportunities, and we have found a couple of stories that we really like.

In Russia, we have been investing selectively in short-dated names in the energy and resource sectors including Gazprom and Lukoil. Russian credit sold off last year as the conflict in Ukraine, the country’s involvement in Syria and the oil price sell-off caused the rouble to depreciate. Investor aversion towards Russia has meant we have been able to find companies with what we believe are double A and single A rated balance sheets whose bonds trade on a yield typically more appropriate for double B or single B credits.

India is another emerging market story we like. Monetary policy has become more prudent and consistent. Inflation has fallen from a peak of 11.2% in November 2013, aided by lower oil prices which has supported the rupee against major currencies. Our approach has therefore been to seek longer-duration local currency bonds. We rely on rigorous credit analysis to select what we believe are the right names, particularly as the quality of corporate governance remains low in India.

Will emerging currencies keep depreciating vs the US dollar?

With the US Fed raising rates in December and economic weakness persisting in emerging markets, we believe the trend will be for gradual depreciation of emerging currencies.

Which are the main risks for the fixed income market these days?

US Fed policy mistake, China hard-landing, emerging markets crisis.

We have seen a notorious crisis in the high yield market in the last weeks. What is exactly happening? Does the lack of liquidity concerns you?

Much was written at the end of last year concerning certain US funds that have frozen redemptions. In addition to this we have seen material outflows from US high yield mutual funds. We have been concerned about US high yield for some time, and have limited exposure to this market. Furthermore, the other concern we have had for a while is some sort of contagion to European credit as credit in emerging markets and US credit have continued to come under pressure. For this reason we have been reducing our European high yield exposure and within our high yield bucket we have been improving the quality and also preferring shorter dated paper.

Yes, liquidity has been the other big risk for the credit market. Due to regulatory reasons investment banks simply cannot support the markets as well as they did in the past. At this late stage of the credit cycle, and with the Fed tightening policy even further (the combination of a strong dollar and quantitative easing coming to an end in the US is a tightening of economic conditions in our opinion) caution is warranted.

What are the prospects for inflation in Europe? Do you see value in the inflation-linked bonds?

We think inflation will remain low in Europe driven by stagnating economic growth and lower oil prices. One of the key measures of inflation expectations, the 5y5y forward swap, demonstrates that investors do not expect inflation to increase materially.