Investors in “safe” bonds such as gilts and US Treasuries were hit by capital losses last year as the market anticipated the normalisation of monetary policy from the world’s central banks.
Performance of indices in 2013
Source: FE Analytics
Bezalel (pictured), expects this trend to continue in 2014 as the Fed continues to taper its quantitative easing programme. As a result, the manager is looking further down the credit spectrum for opportunities.
Although higher yielding bonds carry with them the higher chance of default, Bezalel says they offer the best risk-reward characteristics in the current environment of steadily rising yields.
“We remain optimistic about the outlook for credit markets in 2014,” the manager said.
“Our bullish case is that economic data broadly meets expectations and the market factors in an orderly process.”
“Under this scenario, we believe there is potential for high yield bonds to produce decent returns.”
Bezalel says that peripheral Europe is one of the best hunting grounds for fixed income investors as the macroeconomic story there is improving and companies are still bond-holder friendly.
“In terms of strategy, we continue to hold the view that European high yield bonds present some of the most compelling opportunities available for investors in fixed income,” Bezalel said.
“The region is enjoying low default rates, companies continue to focus on repairing balance sheets, the economic backdrop is stabilising and interest rates are likely to remain low for a prolonged period.”
“These conditions contrast with those in the US where companies are more confident and therefore more willing to take on leverage.”
FE Trustnet recently reported that the manager holds an overweight position in Greek and Cypriot government bonds in particular.
On a sector level, Bezalel says investors should concentrate on financials. The manager says the tight regulatory environment means bank debt looks attractive.
“Banks are in the midst of a multi-year deleveraging process which could see them revert back to utility-style businesses in the world of fixed income. This is providing opportunities for bond investors, in our view,” he said.
However, although both financials and peripheral European debt are bullish calls, the manager notes there are a number of worrying headwinds that mean bond investors need to be cautious.
One of the major threats facing the fixed income market is the possibility that economic growth exceeds forecasts. This could mean central banks may be forced to raise interest rates, which could lead to huge capital losses for bond-holders.
As a result, Bezalel is also building layers of defence into his portfolio.
“While these opportunities are certainly a cause for optimism, it is important not to be complacent,” Bezalel said.
“We are taking particular care to manage risks associated with changing interest rate expectations.”
“At around two years, portfolio duration is relatively low. This has been achieved via short positions in US Treasuries, where we see yields drifting higher over the coming year, and by having a significant weighting in floating rate notes.”
“In the event that economic data in the US (and elsewhere) surprises significantly to the upside, we may look to employ other tools to seek to defend the fund,” he added.
There have been instances in the past where interest rates have been hiked unexpectedly. In 1994 the Fed, under the chairmanship of Alan Greenspan, raised short-term interest rates, causing a sell-off in both bond and equity markets.
Performance of indices in 1994
Source: FE Analytics
A number of fund managers, such as JOCHM’s Christopher Lees and Clive Beagles, have warned there could be 1994-style volatility in financial markets as the US economy is getting stronger and stronger.
Bezalel says such an occurrence is not out of the question as the Fed faces a “formidable task” in terms of managing interest rates and the bond market. However, the manager says that investors shouldn’t be too concerned about that scenario yet.
“This seems unlikely for now, as low US inflation is currently giving the central bank cause for concern and a justification for maintaining a gradual approach to tapering.”
“Ben Bernanke even highlighted that the Fed may consider further action if inflation does not move up towards its 2 per cent target.”
“However, should growth start to accelerate, US inflation data will receive close scrutiny and is likely to be a particularly important indicator for shaping bond market sentiment in the coming year.”
Bezalel has managed the now £1.6bn Jupiter Strategic Bond fund since its launch in June 2008.
According to FE Analytics, over that time it has been the best performer in the IMA Sterling Strategic Bond sector, with returns of 77.54 per cent, and has beaten its iBoxx Sterling Non-Gilt All Maturities index benchmark by more than 30 percentage points.
Performance of fund vs sector and index since June 2008
Source: FE Analytics
The Jupiter Strategic Bond fund also boasts top-quartile returns over one, three and five years.
The manager is also delivering an inflation-busting 5 per cent yield, helped by the overweight position in Cypriot and Greek government bonds.
The manager’s largest credit exposure is in B and BB rated bonds, which make up 27.21 per cent and 24.74 per cent of his fund, respectively. He also has a 9 per cent weighting to un-rated bonds.
Jupiter Strategic Bond has an ongoing charges figure (OCF) of 1.49 per cent and requires a minimum investment of £1,000.
