Global fixed income markets are poised at a critical inflexion point as monetary policy normalisation, US fiscal stimulus and incipient inflation threaten the post-crisis status quo, according to Nik Persic, co portfolio manager with credit specialist firm Bentham Asset Management.
Persic, in NZ last week on client visits, said rising interest rates in the US combined with ‘quantitative tightening’ – or the reversal of crisis-mode Federal Reserve ‘quantitative easing’ techniques – and President Trump-approved tax cuts that will tip US$1.2 trillion into an at-capacity economy had put traditional fixed income investors on edge.
“We expect there will be an inflation surprise on the upside,” he said. “This is a very precarious time for fixed income investors.”
The pressure on global bond markets would likely flow on to equities, Persic said, with potential easing of historical diversification benefits of investing in both asset classes.
“We’re now seeing more incidents of positive correlation between bonds and equities,” he said.
Persic said given the broader market conditions, Bentham, which manages about A$8 billion in a range of credit funds including two NZ dollar-hedged versions, had moved to cut some interest rate risk from its portfolios.
The diversified credit Bentham Global Income Fund (GIF) was now 2.5 per cent short benchmark duration, he said.
Bentham has dialed back the interest rate exposure by weighting the portfolio to floating rate securities as well as imposing a derivative overlay of short futures and interest rate swaps.
“Floating rate assets will benefit from rising cash rates – there’s some interesting opportunities in loans and asset-backed securities,” Persic said. “We’re avoiding traditional fixed income markets that have been artificially supported by central banks, such as European investment grade bonds.”
And while the credit market has not been immune from the wider fixed income repricing, he said it continues to offer diversified sources of return for investors.
“On the risk side we’ve reduced our exposure to high-yield bonds,” Persic said. “The core of our portfolio is in global syndicated loans.”
The Bentham GIF invests in about 600 underlying credit securities about half of which are investment grade.
Last year most credit markets returned about 2-4 per cent above cash before easing off to about 1.5 per cent in 2018 to date, he said.
The GIF targets a spread of 3.5 per cent above cash (as measured by the bank bill rate).
Over the 12 months to the end of April the $95 million NZ dollar-hedged GIF earned a total return (yield plus capital gain) of almost 7.5 per cent after fees while the $35 million Syndicated Loan Fund (SLF NZD-hedged) racked up a 5.6 per cent performance over the same period. Since inception late in 2013 the NZ dollar versions of the Bentham GIF and SLF have produced respective after-fee returns of 7 per cent and almost 6.8 per cent.
Persic said investors both sides of the Tasman are increasingly allocating to credit assets as a way to diversify and access higher yields.
He said the asset class was “much-maligned” in the wake of the GFC where instruments such as credit default obligations (CDOs) copped the blame for imploding markets.
“All parts of the credit market were tarred with the same brush,” Persic said. “But even some parts of the CDO and CLO (collateralised loan obligation) markets have done quite well since the GFC.”