Low yields on traditional fixed interest instruments have pushed many bond managers into riskier investments, as FE Trustnet recently highlighted.
FE Alpha Manager Bezalel, who has managed the highly popular £1.7bn Jupiter fund since its launch in June 2008, took the decision to buy Greek and Cypriot short-term paper at the back end of last year when it was yielding 9 per cent. He has since built up a healthy position in the instruments. Both Greece and Cyprus carry a lot of bad press, but while Bezalel says that peripheral Europe still has issues that need ironing out, he believes the macroeconomic story is getting better and the probability of default is diminishing.
“The Greek and Cypriot bonds have been on absolute fire today,” Bezalel said.
“That is mainly because economic data out of the eurozone is improving. We have seen some really good PMI numbers coming out of the likes of Spain, and Portugal has recently passed its bailout review.”
“In terms of Greece, I am not saying they are out of the woods yet by any means, as a lot more work needs to be done, but there is a lot more support coming through now from Germany.”
“Am I taking much risk for yield? It is a good question, but what I would say is that all the same bottom-up fundamental work is still being done. We are not being stretched into stuff we don’t want to be in,” he added.
According to FE Analytics, Jupiter Strategic Bond has been the best performing portfolio in the IMA Sterling Strategic Bond sector since its launch, with returns of 78.1 per cent. It has beaten its iBoxx Sterling Non-Gilt All Maturities benchmark by close to 40 percentage points.
Performance of fund vs sector and index since June 2008
Source: FE Analytics
It has also outperformed both the index and its competitors over three and five years, comfortably sitting in the top quartile over both periods.
Another area the manager is turning to that is usually regarded as risky is derivatives.
In December last year, Bezalel wrote to his investors seeking permission to use derivatives more extensively within the fund in a bid to protect it in times of market stress.
He now has the ability to use credit default swaps (CDSs) in the portfolio, which he says will help limit the amount of risk it takes on.
“We are not trail-blazing here, we are just playing catch-up,” he explained. “To be honest, we have [so far] only being using them for indices and what I explain to clients is that CDSs are just another tool in my box for protecting their money.”
The CDS market allows investors to insure themselves against non-payment, as the risk of default is transferred to the seller of the swap. They also allow buyers of the swap who think there is a good chance of default to benefit.
Bezalel says that the use of CDSs has not affected the way in which the fund is managed now, and will not affect the way it is run in the future. This is an issue that FE Trustnet queried last week.
“Hopefully it will change nothing,” he said. “It is there to be used in times of volatility, as in the past we would be shorting government bonds, but now the fund is a bit bigger, CDSs are more effective. They help me to implement my macro view and help when I try to add value.”
“Last year we targeted a return of around 6 per cent, which we achieved. This year we are targeting a mid-single digit return, which in a world where you are getting nothing from cash in the bank, I think is quite appealing,” he added.
Although he has the ability to use CDSs in his fund, Bezalel says he is not going to get carried away and instead is using the same measures to protect downside risk that he has been using for the last 18 months or so.
“The way I see CDSs is if there is a black swan event, I can use them to protect the credit book. However, in a rising interest rate environment like the one we are in now, we will be using more floating-rate notes, which we have been buying recently.”
“We have also been reducing duration in the fund – the duration is currently one and a quarter years – by shorting govies [government bonds],” he added.
As Bezalel recently told FE Trustnet, he favours lower corporate credit as he expects prices of government bonds such as gilts and Treasuries to continue to fall next year as the global economy improves.
Performance of indices in 2013
Source: FE Analytics
Bezalel’s base case scenario is that yields on government bonds will gradually trend higher throughout 2014 and that securities such as 10-year gilts – which currently yield just under 3 per cent – will be around 3.5 per cent at the end of the year.
However, he says the biggest threat to that scenario and to the global bond market would be economic data beating expectations, which could cause central banks to hike interest rates.
As a result, Bezalel says he needs flexibility within his fund; this is something that CDSs give him.
He adds that the outlook for single-strategy fixed income funds looks precarious for the foreseeable future. However, because he now has a vast array of tools at his disposal, Bezalel says he can still deliver decent returns.
“It’s a bit of no-brainer, really,” he said. “Given where we are in the rate cycle, there is the increased probability rates will drift higher.”
“As that happens, you need a lot of tools in the box. The beauty of this product is that I can now gain access to any market and position the fund according to how I see the macro.”
“Single-strategy funds like corporate bond funds have to limit losses. I hate having to do that and though I am always trying to protect my investors’ capital, I want to be able to add value,” Bezalel added.
Jupiter Strategic Bond has an ongoing charges figure (OCF) of 1.49 per cent and requires a minimum investment of £500.
Click here to learn more about bonds, with the FE Trustnet guide to fixed interest.
