Fixed income faces many challenges today, but Ariel Bezalel, manager of the Jupiter Dynamic Bond, explains how, by combining a top-down and bottom-up approach with flexible management, opportunities can be found. Its bets: the financial sector of developed markets and emerging markets like India (debt in dollars and also in local currency). In this interview with Funds Society, he also explains how he keeps the risk of duration in the face of rising inflation and political risks in Europe.
Many experts say that the biggest focus of trouble could be now in fixed income: Is it true that nowadays fixed income has a higher risk profile than other assets? Why?
Undoubtedly, with yields at today’s levels it is not easy to achieve compelling returns. We will however have to work hard to spot the opportunities given the low yield environment. A key to this is our time-tested process combining top-down and bottom-up analysis as well as our flexible, unconstrained mandate. That flexibility enables us to find those opportunities.
It is worth mentioning as well that despite the rate hikes expected by the market, we expect that the role of the fixed income asset class as a volatility dampener in a diversified (bond/equity) portfolio will remain.
It seems that the inflation is going to rise suddenly… Are you amongst the people who think that or do you think expectations are overstated?
Inflation in the developed world has certainly been picking up. Market indicators, such as breakeven inflation rates, are rising in the UK, US and Germany, putting upward pressure on government bond nominal yields. Elsewhere, economic growth in China is ticking along nicely, reflected in resilient commodity prices and brighter US service sector data and wages.
Donald Trump’s election of course is a further inflationary signal. The US president’s rhetoric points towards potentially faster economic growth, and with an economy almost at full employment, inflationary pressures are bound to build. However, Trump still has yet to implement his plans and there is still a lot of uncertainty around the plan and the timeline.
Do your inflation expectations have any impact on the portfolio of your fund? Are you preparing for the rise of the inflation or it is too soon?
We are fortunate that our strategy’s unconstrained mandate means we can select what we consider to be the best opportunities across global bond markets while seeking to carefully mitigate risk, in part through management of duration which we continue to keep low. In credit, for instance, as we see inflation risk picking up and favour short-dated paper with decent carry alongside ‘special situations’ where we see the possibility of capital gains.
With inflationary pressures building up in Europe, and rising political risk surrounding the French elections, we have also initiated a short position in French government bonds over the months.
Do you believe that this a moment to be cautious with the duration and to assume risk in credit, or are there various shades to this idea? Why?
We are balancing careful management of duration with a reactive approach to market developments and continue to use the strategy’s unconstrained mandate to exploit ‘special situations’ where we see the possibility of capital gains. That said, we have been steadily reducing duration, starting in August 2016, to help insulate the fund from rising rates.
Regarding central banks: have the markets already discounted the interest-rate hikes what the Fed is expected to make this year?
Markets are currently pricing in a 30% probability for a rate hike in March due to lackluster average earnings and the back-up we’ve seen in 10-year yields. The markets though see 50/50 chance of the Fed raising in April, and a close to 70% chance of a hike in June. However these probabilities may change significantly as Trump fiscal policy unfolds during the year.
Will the ECB take progressive measures also in terms of "taper tantrum" in the mid-term? Will it be more difficult for Europe than for the US to withdraw stimulus? What will be the effects on the European debt market?
The ECB’s decision to reduce its monthly asset purchase programme from €80bn to €60bn in April demonstrates the pressure the central bank faces from hawkish members to reduce the pace of the programme. While the ECB would seek to minimise disruption in the bond markets, it will be more and more difficult to justify QE as inflation picks up in the euro zone. Another very significant event risk for peripheral spreads in Europe will be the French elections in May. A victory for Marine Le Pen would likely trigger a significant widening across European peripheral spreads.
In which segments of the fixed income market do you see the best opportunities these days? (by regions, sections, countries ... and by public or private debt)
Within developed markets we see opportunities in the banking sector as it benefits from both the reflation in the global economy and a secular trend towards deleveraging. EM is another area we like. However one has to be very selective. One of our main picks is India where the combination of favorable demographics and improvement of the institutional framework since Modi’s arrival to power have underpinned our investment thesis.
Because of the next rate hikes, is it a good moment to invest in the banking sector? Many people are talking about the attractive of the subordinated bank debt. Do you agree with them?
Banks remain a favoured sector for us because secular deleveraging combined with steeper yield curves should ultimately benefit bond investors in this area, particularly junior bond holders, although one has to be selective.
What are your views on EM debt? Do you prefer local or hard currency?
There are some exciting opportunities in emerging markets. We have been increasing our exposure to Indian bonds because of the country’s favourable long-term economic and political backdrop, putting us in a position where we are able to capture attractive yields. I’m very encouraged by India. It is a very insular economy; it doesn’t rely too much on exports, it doesn’t have much dollar-denominated debt and the current government is a very business-friendly administration that is really picking up on implementing reforms over the last year or so. We invest in both dollar-denominated and local currency bonds.
Do you believe that public Spanish debt has potential or this is not a good time to invest?
We have limited exposure to peripheral Europe due partially to the uncertainty surrounding the European project. However, one has to recognize that Spain’s economy is showing great strength underpinned by the structural reform undertaken following the crisis in the euro zone debt crisis.