Rising global interest rates have made if difficult for global bonds to perform so far this year.
Meanwhile, geopolitical risks have led to a significant correction in bond markets, particularly within emerging economies, and to a certain extent in select developed market countries such as Italy.
In the year to the end of September, the global bond market, as represented by the Bloomberg Barclays Global Aggregate USD Hedged index, returned 0.02%.
Sovereign yields were broadly higher across developed markets.
In the US, for example, the yield on 10-year US treasuries rose by 66 basis points as the economy experienced strong growth and the Fed continued to raise interest rates.
Elsewhere, yields in Japan rose by eight basis points following changes to the Bank of Japan’s yield curve control framework in July.
Furthermore, within spread markets, global investment corporate credit spreads have widened 18 basis points as measured by the change in OAS for the Bloomberg Barclays Global Aggregate Corporates index.
What came perhaps as a bigger surprise this year was the fact that markets were at times dominated by correlation shocks, in which both equities and fixed income underperformed at the same time.
This was particularly evident at the start of the year and again in the first two weeks of October.
The pressure on interest rates to rise further continues to be a key theme as several major central banks are withdrawing liquidity from the market, Citywire A rated Arif Husain said.
‘In this environment, there is a strong case for long-maturity bonds in developed markets to correct further,’ he said.
‘However, the yield curve also appears very flat at present and we have started to look for opportunities to move back into shorter-term bonds in the US.’
Husain, who runs the T. Rowe Price Global Aggregate Bond fund, is ranked fifth in his sector over three years with a return of 10.11%.
His fund invests in a wide range of countries and currencies by selecting different types of sectors and issuers around the world.
During the few months to mid-October, Husain has gradually moved to an underweight duration stance versus the benchmark by adding short positions in eurozone government bonds and in Japan.
‘In the US, we decided to use fixed income options to express a negative duration bias,’ Husain said.
Cautious on EM
Citywire AA-rated Andrew Norelli said central bank balance sheet reduction remains a key driver of global bond markets.
Norelli, who manages the JPM Income fund, is ranked fourth in his sector over three years with a return 13% versus the average manager’s 6.39%.
‘Given our expectation that Fed balance sheet normalisation would negatively impact USD liquidity, we have been patient in allocating to emerging markets and adding to duration,’ he said.
JPMAM’s cautious approach to EM – both in an outright low allocation and through selectively hedging its exposure – has been beneficial to the JPM Income fund’s year-to-date performance.
‘Instead, we have a current bias toward US fixed income, relative to emerging markets and other developed markets globally,’ Norelli added.
Within US fixed income markets, the fund has focused on building allocations between high yield corporate bonds and consumer asset-backed securities.
The fund invests in a diversified portfolio of investment grade bonds denominated in major world currencies.
The portfolio managers said: ‘We want to maintain flexibility to respond to both positive and negative shocks.
‘If we need to give up some portfolio yield in exchange for this flexibility – for example, by holding more highly liquid short-term instruments – then that looks like a reasonable trade-off in the current environment.’
The PIMCO team added that the fund aims to generate income from a broad range of sources, without relying on corporate credit overweights.
In the year to the end of September, the PIMCO GIS Global Bond fund has increased its exposure to US treasury inflation-protected securities as a hedge against higher inflation in the US.
It has also added to allocations in investment grade financial corporate bonds.
This article was first published in the November issue of the Citywire Private Wealth magazine.