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Why there’s no need to fear a 1994-style crash in bonds

13 June 2013

Enzo Puntillo of the Julius Baer Total Return Bond fund says investors will wonder what all the fuss was about when they look back on this period 18 months from now.

By Thomas McMahon,

Senior Reporter, FE Trustnet

Investors are over-reacting to the recent rise in US yields, according to Enzo Puntillo, head of fixed income at Swiss & Global Asset Management, who says that fears of a 1994-style double crash in bonds and equities are overblown.

ALT_TAG Federal Reserve chairman Ben Bernanke has spooked the markets by suggesting the end of the bank’s quantitative easing [QE] policy could be on the cards following a positive period for the US economy.

Since then, both the bond and equity markets have seen signs of strain, with yields rising on US Treasuries and global markets falling.

However, Puntillo says that investors must not get too caught up in the current market volatility, which will clear in a matter of months.

"If we look back from 18 months in the future, we will probably see something 'less worse' than what the market is starting to price back in," he said.

"There’s no reason for a repetition of the '94 reaction when Greenspan suddenly surprised the market verbally and then acted directly."

"You need action from the central banks that’s severe to get a '94 reaction, so we will have a few more weeks of volatility, but when we look back in 12 to 18 months we will see something better."

The paradox of the market turbulence is that improving economic news from the US has led to assets selling off, as a healthier economy will eventually lead to the Federal Reserve withdrawing from the QE programme that has supported markets and held yields low.

Puntillo says that there are still two reasons to be wary of this recovery, and the end of QE is still some way down the line.

"Normalisation won’t be that quick after the next correction," he said. "Firstly, the debt situation in the US is still very high, so the FOMC will not act too heavily at this stage."

"Secondly, jobs data is improving but the participation rate is still low," he added. "A lot of people are basically out of the market. Nobody who has gone out of the market in the correction has gone back in."

He also points out that the tapering of the QE programme will have some counteracting effects to rising yields.

"If the tapering starts, the inflation expectation will come down, so yields will come down more."

Puntillo is the head of fixed income at Swiss & Global and manager of the €391m Julius Baer Total Return Bond fund.

The fund has made 15.51 per cent over the past three years in sterling terms, ahead of the average fund in its offshore global fixed interest sector, which is up 13.92 per cent, according to data from FE Analytics.

Performance of fund vs sector and benchmark over 3yrs

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Source: FE Analytics

The fund has been almost twice as volatile however, with an annualised score of 8.27 per cent over the period, compared with 4.1 per cent for the sector.

There are no sterling share classes available and the returns in US dollars have been higher, at 23.81 per cent to the 22.8 per cent of the sector.

The manager says that he has moved back from high yield securities in recent months.

"The hunt for yield is not justified from valuations any more: the spreads do not justify it. In fact, it was over months ago."

He is also starting to very slowly position his fund for a tapering of QE at the longer maturities.

"We went short duration for the first time last month," he said. "When the economic cycle recovers and there’s enough room to adjust, we started shorting 30-year as we saw some upside."

The manager says he is also starting to short the 10-year US Treasury as the correction continues, and he says that it could be more vulnerable than the 30-year one.

The fund is unconstrained by geography, and has invested in selected emerging market bonds in the past.

However, the manager says he has been reducing his weighting to emerging market debt, which has been hard hit in the correction. Some bonds are starting to look attractive in the space again, he says.

Puntillo is not surprised by the rough ride the Japanese market has had; the Nikkei 225 was down 11.79 per cent from its recent highs at the close of play yesterday and has fallen further today, pushing it into bear market territory.

Performance of index over 1 month

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Source: FE Analytics

"Japan went up too much and we will pay the price now of additional volatility," Puntillo said.

"The last action of the Bank of Japan has added volatility, even though QE1, QE2, QE3 and Operation Twist all reduced volatility."

The manager says that although he thinks the market has over-reacted to Bernanke’s comments, we are seeing the beginning of a gradual "normalisation" of interest rates, which will result in high volatility as it settles.

This was the case when this process happened in 2004 and 1994, but Puntillo says that the dramatic crash in the markets that was seen at the earlier event is unlikely to happen again.
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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.