Equity markets have been falling over the last month with the imminent end of QE, slowing growth in the eurozone and mounting geo-political issues all contributing to the correction.
However, higher risk areas of the fixed income market, such has high yield credit, have shown signs of weakness as well.
Traditional safe havens such as gilts, on the other hand, have rallied and 10-year gilts currently yield 1.96 per cent.
As a point of comparison, they had a yield of close to 3 per cent at the start of the year.
Performance of indices since Sep 2014
Source: FE Analytics
Bezalel had been running a relatively risk-on portfolio over the last year or so in preparation for higher interest rates and stronger economic growth.
However, with new information presented to him, he has retreated back into defensive assets such as government bonds and has also terminated a number of the shorts which were in place to benefit from rising yields.“For much of this year we have been at the more hawkish end of expectations on US rates, believing the market could be underestimating a potential pickup in growth in the domestic economy,” Bezalel said.
“We have recently modified our views on concern that the US economy is not immune to mounting external risks. As a result we have moved into capital preservation mode and have made a number of tactical changes to the fund.”
Bezalel had held a much more bullish portfolio at points this year. As of his August factsheet, he held 27.1 per cent in BB-rated bonds, 38.1 per cent in B or lower rated bonds – including 10 per cent in non-rated credit – and his portfolio’s duration, which is a measure of interest rate sensitivity, was just 2.17 years.
This positioning has weighed on performance however as, according to FE Analytics, the £2.3bn fund has underperformed against both the IMA Sterling Strategic Bond and its iBoxx Sterling Non-Gilt All Maturities benchmark this year with returns of 3.19 per cent.
Performance of fund vs sector and index in 2014
Source: FE Analytics
Jupiter Strategic Bond now looks very different, according to Bezalel.
“In the US, we have cut the five-year treasury short position. Risks are now much less biased towards a second ‘taper tantrum’ and we are more inclined to think that lower rates are here to stay for a while.”
“In Australia, we have increased our government bond allocation aggressively to about 22 per cent, thereby building more caution into the portfolio. Compared to other sovereign bonds, Australia continues to look appealing in our view.”
“The overall duration of the portfolio has moved up by around two years to 4.5 years today. We continue to hold a 10 per cent long in the US dollar, which has worked well as a hedge against macro uncertainty.”
Bezalel says there have been a number of factors that have made him change his tune on the medium-term outlook for the bond market.
“We believe the market has been complacent in the face of geo-political risk and are worried by the relatively limited market reaction to heightened levels of global uncertainty across a number of regions – Syria, Iraq, Hong Kong and Russia/Ukraine – while the potential spread of Ebola is also of concern.”
“While we continue to monitor the risk of inflation in the longer term, especially if the job market tightens in the US, falling inflation has become a more acute near-term risk, in our view.”
He says this is shown in a number of indicators, such as a sharp move lower in US breakevens – which are inflation expectations as calculated by comparing the yield of inflation-linked bonds and conventional treasuries – the rally in the US dollar, which reflects tighter global liquidity and lower domestic inflation, and falling commodity prices.
This has meant the FE Alpha Manager has also changed his view on US monetary policy as, while he still anticipates QE to stop at the end of the month, he thinks market expectations about the future of interest rates are way off target.
“It is now up for debate whether rates will rise in 2015 and we have become more aligned with the market’s expectation that interest rates will rise more steadily and will be data sensitive,” Bezalel said.
“The current environment appears too fragile for a hawkish stance from the Fed and we believe further evidence of deflationary pressure could trigger more dovish comments from chair Yellen.”
His other major concern surrounds slowing growth in the eurozone. Data today shows that inflation in the eurozone has fallen to just 0.3 per cent and, like chancellor George Osborne warned the market last week, this weakness is likely to have an impact on the UK economy.
“The UK economy, while reasonably buoyant to date, may not be immune to eurozone weakness, given the importance of its exports to the region,” Bezalel said.
“While we still believe the Bank of England is nearer to tightening than any other major central bank, the timing of this is less certain. In addition, the prospect of Labour coming to power in 2015 could put downward pressure on sterling.”
Though the relative performance of Bezalel's fund has been weak this year, it hasn’t detracted from his longer-term numbers.
According to FE Analytics, it has been the second best performing portfolio in the IMA Sterling Strategic Bond sector since its launch in June 2008.
It has returned 83.26 per cent over that time, beating its benchmark by 23.32 percentage points.
Performance of fund vs sector and index since June 2008
Source: FE Analytics
The fund has also outperformed its sector and benchmark over three and five years.
Jupiter Strategic Bond currently yields 5.2 per cent, but investors can expect that to change given his recent portfolio activity. It has a clean ongoing charges figure (OCF) of 0.74 per cent.
