May’s guest interview
Ariel Bezalel (Head of Strategy, Fixed Income at Jupiter, and Lead Portfolio Manager of the Jupiter Dynamic Bond Fund) talks to Ian Aylward (Head of Manager Selection at Barclays) about global bond markets and how he is positioning the Fund accordingly.
IA: The market environment in 2018 is very different to what we have been used to over the last few years.
AB: The challenging and volatile conditions so far in 2018 will, I believe, continue throughout the second half of the year and beyond. We see several signs that point to the risk of a potential synchronised slowdown and numerous symptoms that we are in the latter stages of the economic cycle.
After a decade of gently rising equity markets and broadly low volatility in bond markets, it is understandable for investors to feel rattled by recent volatility. For the last decade, central banks have used low interest rates and bond-buying through quantitative easing programmes to support financial markets and aid the recovery after the financial crisis.
Now that central banks are withdrawing this support, led by the Federal Reserve in the US, more frequent bouts of volatility are not surprising.
IA: What are your main concerns about reversing QE?
AB: We believe that the Federal Reserve will encounter difficulties trying to tighten policy this year. US corporate leverage is at record highs, and the US consumer is under pressure, with rising delinquencies on credit card debt and auto loans. The sharp rise in the US dollar LIBOR rate and risk of higher gasoline prices will also add further strain to the US consumer.
Given the weak underlying economy, we believe that the long end of the yield curve will compress lower to reflect weaker growth and inflation expectations. Considering the underlying weaknesses, we believe two or three rate rises could be the end of this hiking cycle, after which we could expect to see a return to unconventional policy measures as the US economy takes a step backwards over the next year or two.
IA: Does this lead you to taking a defensive approach within the fund?
AB: I’d call it a more ‘prudent’ approach. There are still opportunities out there to invest in, but we have to be mindful of the risks. So, we run a ‘barbell’ strategy, which involves balancing medium and long-term US and Australian government bond positions with selected opportunities in credit markets, high yield, and emerging market debt.
In our view, the global synchronised growth of last year is at risk of giving way to a synchronised slowdown, which we believe would lead to a rally in the medium- to long-term part of the Treasury curve. We raised overall duration gradually over the last year or so to around 5.9 years.
IA: Can you talk us through the government bond exposure?
AB: Government bonds exposure has weighed on the fund’s performance recently as yields have risen, but we believe this should reverse as we enter a period of increasing volatility in the second half of the year. Despite the volatility in US Treasuries, we believe that the market feels well-supported from a technical standpoint. Speculators are currently running record shorts on most points of the US Treasury curve. In light of this, we have been using the opportunity of rising yields to gradually increase the duration of the US Treasury portfolio.
IA: So, if that’s your ‘defensive’ part of the portfolio, what sorts of opportunities are you finding?
AB: While emerging markets are volatile, we see opportunities in selected emerging market corporates with strong balance sheets and a long-term positive economic outlook. European banks are another area we like, especially the legacy tier-one debt. These bonds provide less yield than CoCos, but are less volatile. A bonus is that banks frequently buy back these instruments and sometimes at a substantial premium due to increasing pressure from regulators.
IA: And you mentioned emerging markets earlier?
AB: Yes, we see a number of opportunities in emerging markets. We added to our Russian exposure, especially to Russian corporates with strong balance sheets. We continue to see India as a long-term opportunity and believe concerns over India’s inflation outlook are short term. Since the strategy’s exposure is mostly to the short end of the yield curve, it was minimally affected by the recent sell-off.
IA: And finally, over the years we have got to know the various ‘special opportunities’ that you and the team at Jupiter have played in the fund. Any interesting stories or themes today?
AB: Despite our more cautious approach, we are not held back from discovering special situations in high yield. An example could be a position we have added in Boparan, the UK chicken producer, which had been trading at distressed levels. Another interesting area in European high yield, in our view, is the seemingly unloved retail sector. While concerns over online competition and high levels of debt abound, bonds of companies such as Matalan and Shop Direct offer value. With high single-digit yields, we believe investors are being well compensated.
IA: It certainly sounds like fixed interest is an interesting place to be.
AB: Yes. We believe that problems in the US economy are yet to fully surface but that they should help to keep a lid on inflation and therefore bond yields, as consumers feel further strain from a weaker underlying economy. We believe that now is a time for caution, but also remaining alert to opportunities. We believe this is the right strategy as we enter a sustained period of uncertainty and volatility.