The outlook for fixed income

1 March 2014 - Jupiter Strategic Bond has been on the Chelsea Core Selection since March 2012. The fund has a Chelsea Risk Rating of 2. We invited the manager, Ariel Bezalel, to talk about his process and the outlook for fixed income.

Ariel Bezalel, manager of Jupiter Strategic Bond

I joined Jupiter in 1997 as a member of Jupiter’s fixed interest/multi-asset team and I currently manage the Jupiter Strategic Bond fund and an offshore fund with a similar remit. I gained a degree in Economics from Middlesex University.

I believe a flexible ‘go-anywhere’ approach to bond portfolio management has the potential to deliver positive returns through the economic cycle.

The tapering effect...

With self-sustaining growth returning to the US, the decision by the Federal Reserve (Fed) to reduce the pace of its quantitative easing programme in December 2013 marked something of an inflection point in terms of central bank policy. For bond investors, who over the past five years have benefited from accommodative central bank policies worldwide, this raises some concerns.

Since the Fed forewarned of an imminent change in policy back in May 2013, we have already seen emerging market bonds and currencies come under acute pressure. For central bankers in the UK and Europe, the Fed’s revelation put them onto the back foot, arguably forcing both to give forward guidance in the summer to reassure markets that interest rates would remain lower-for-longer. Given the role of US Treasury bonds in the pricing of risk and therefore bond yields globally, these were unusual times. 

...and what this means for us

In answer to those concerns, we are generally optimistic about the outlook for credit markets in 2014. We believe there is a good chance that the combination of low inflation and reasonable growth in the US will provide the right conditions for the Fed to withdraw from its policies gradually and without too much market uncertainty.

Nevertheless, we remain pragmatic and firmly believe that at times like this our unconstrained ‘go-anywhere’ approach to managing the Jupiter Strategic Bond fund puts us in a good position to face a challenging policy backdrop. Being unconstrained means we are under no obligation to adopt benchmark weights and have the freedom to invest globally and across the ratings spectrum.

When investing, we are especially cognisant of the macroeconomic outlook to determine how ‘risk on’ or ‘risk averse’ we want to be. This typically impacts decisions about how much high yield to hold in the fund and the portfolio’s duration (i.e. sensitivity to interest rate changes). Our expectations for the global economy also inform our yield curve positioning (i.e. allocation to bonds of different maturities). 

Under scrutiny

However, forming accurate views about the global economy is only one part of the equation. It is our view that the strong performance of the fund since its inception is testament to the careful credit analysis that we carry out on every company in which we invest, although past performance is not an indicator for the future. In terms of basic principles, we start out by considering the worst case scenario rather than upside potential and carefully scrutinise a company’s ability to pay interest and repay the capital at the end of a bond’s life. This approach has enabled us to participate in some compelling and lucrative opportunities since the fund’s inception in July 2008. 

In the past 12 months, we’ve been particularly attracted to high yield bonds in Europe where interest rates are low and companies are still very focused on improving their balance sheets. Deleveraging in the European banking sector, whereby banks reduce the level of debt on their books, is a multi-year investment opportunity in our view and this is a core investment area in the fund.  Banks are being obliged to continue to improve their balance sheets to ensure they pass stress tests (a health check conducted by the European Central Bank) in the second half of this year. For debt investors, stronger balance sheets are a big plus as it typically means a company is in a good position to service its debts. We are also attracted to niche areas like oil rig financing, pub-securitisation and debt purchasing. 

While we do not really see much upside in high yield bonds this year, our portfolio of bonds continues to pay very healthy interest. And while we see government bond yields drifting higher in the US over the course of 2014 as economic conditions continue to improve, we retain a very large hedge in US Treasury bonds to help insulate the fund against the impact of this.  Emerging market debt is to be avoided for now, in our view, but we are finding compelling oil plays in Mexico, one of our preferred emerging market plays. 

The investment policy of the fund has recently been expanded to allow the use of derivatives for investment and hedging purposes. We did this primarily to augment the tools at our disposal to manage risk in the fund and to help mitigate the risk to investors’ capital in times of volatility. As mentioned, we currently use government bond futures to hedge interest rate risk in the portfolio and may, under certain circumstances, use credit default swaps (derivatives designed to offer protection against default risk) to hedge specific parts of our corporate bond exposure. This risk hedging is not, of course, guaranteed.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Ariel's views are his own and do not constitute financial advice.