The recent chaos in the equity market, along with low growth and the threat of deflation, means bond yields are likely to fall further from here, according to FE Alpha Manager Ariel Bezalel, who has upped his exposure to longer-dated assets within his Jupiter Strategic Bond fund as a result.
Fixed income had fallen more and more out of favour with investors due to the extremely low yields on offer and the significant price falls in the likes of US treasuries, UK gilts and German bunds earlier in the year seemed to validate that view.
On top of that, with many expecting a rate hike in the US and UK the consensual view was that bond yields would spike further, leading some to suggest that there would be devastation in the fixed income market.
However, despite all the talk of high correlations between bonds and equities, sovereign debt has once again taken up its role as hedge against risk assets during the recent crisis.
Performance of indices over 1 month
Source: FE Analytics
Following the significant falls during ‘Black Monday’, the likes of the 10-year gilt yields and yields on similarly dated US treasuries have rallied to their lowest levels since April and Bezalel says there are a number of reasons why those moves are justified. 
“We had been pessimistic about the prospects for global growth for some time prior to [Monday’s] sharp sell-off across global equity markets,” Bezalel (pictured) said.
“The sudden deterioration of a range of leading indicators last week, coupled with another leg-down in prices of global commodities, appears to have been taken by the market as an indication that global economic activity is weakening further, led by China.”
“Market sentiment, already jittery ahead of a possible September rate rise by the US Federal Reserve, was chilled further by China’s yuan devaluation two weeks ago, leading to emerging market currencies and assets once again being crushed, with many already at record lows against the dollar.”
“Since the sharp falls in China’s domestic equity markets on Monday, volatility has soared, while yields on ‘haven’ assets such as long-dated US treasuries and German bunds pushed lower as investors flocked out of riskier assets.”
Given the negative sentiment towards bonds over recent times along with the fact yields have fallen a significant amount over the past 10 years, many have viewed the recent snap rally in sovereign debt merely as a dead-cat bounce which is likely to subside when investors once again turn their attention to improving economic data in the western world.
Performance of indices over 10yrs
Source: FE Analytics
“While bonds and cash offer save haven status in such an uncertain world, they do not offer much by way of value and upside in our view from current levels,” Nancy Curtin, chief executive officer at Close Brothers, said.
There is still also the fear (or opportunity, depending on what side of the trade you are on) that the US Federal Reserve will still tighten monetary policy despite the macroeconomic headwinds emanating out of China.
Franklin Templeton’s Michael Hasenstab and Sonal Desai are two who hold this view.
“We continue to expect the US Federal Reserve to raise interest rates in the second half of 2015, although we are not fixated on the exact timing of when the Fed will raise its policy rate. In the event that we do not see a rate hike this year, we feel the market will price in the Fed being behind the curve in light of improving economic data, and the yield curve will likely steepen,” they said.
“We remain confident in our constructive economic outlook for the US economy and believe the market will move in advance of the Fed, regardless of the dovish rhetoric, as it has historically done.”
However, Bezalel has been upping his exposure to longer duration assets (those which are more sensitive to interest rate hikes) as diminishing global growth, falling commodity prices and the devaluation of the yuan are major disinflationary forces which will provide a natural lid for fixed income yields.
“For some months, we have retained an above-consensus average duration of five years in the portfolio as we believe that high debt levels, weak commodity prices and other deflationary forces in the global economy are likely to put a ceiling on economic growth and inflation,” he said.
“As a result, the funds have so far benefited from investors’ flight to safety this week. In addition, the ‘barbell’ strategy we adopted in late 2014, balancing our position in longer-dated Australian government bonds with a selective allocation to high yield, is designed to help the fund withstand volatility in global markets.”
“More recently we have been buying long-dated US treasuries and also bought some two-year US treasuries with the view that a rate rise from the Federal Reserve is currently unlikely.”
His thoughts are similar to those of fellow FE Alpha Manager John Pattullo, manager of the Henderson Strategic Bond fund, who recently told FE Trustnet that there was no bubble in bonds and, as a result, had upped his exposure to longer duration assets.
Bezalel had historically been a manager who was relatively bearish on core developed market government bonds and had therefore ran a portfolio skewed towards higher risk and higher yielding debt.
He changed his portfolio to a more defensively skewed one recently though, which has benefitted his investors.
According to FE Analytics, his £2.6bn fund has outperformed both the IA Sterling Strategic Bond sector and its iBoxx Sterling Corporates All Maturities benchmark so far this year with gains of 1.34 per cent and has largely protected its investors against the major market falls.
Performance of fund versus sector and index in 2015
Source: FE Analytics
“So far this year, this balanced position has acted as a natural hedge, allowing us to take advantage in times of ‘risk-on’ sentiment while mitigating the risk of capital loss in moments of stress,” Bezalel said.
Bezalel is seen as one of the best strategic bond managers available to investors and the FE Research team currently has his fund on its Select 100 list due to the manager’s very active and flexible approach.
“Bezalel has taken full advantage of his unconstrained mandate. By varying the portfolio’s allocation to government bonds or high- or low-rated corporate bonds according to his assessment of the economy, he has generated outstanding performance since the fund’s inception.”
“He has a great deal of experience investing in bond markets and his absolute return mindset gives him an edge over many of his competitors in his sector.”
The FE Alpha Manager launched his fund in June 2008 over which time it has been a top decile performer in the sector with returns of 86.75 per cent, beating its benchmark by close to 25 percentage points in the process.
Performance of fund versus sector and index since launch
Source: FE Analytics
Jupiter Strategic Bond has also beaten its peers in five out of the last six calendar years.
Bezalel’s fund currently yields 4.3 per cent thanks to its overweight exposure to high yield corporate bonds, but the manager is confident that his portfolio is protected against further volatility thanks to his recent treasury acquisitions and long-standing positions in Australian government bonds.
Jupiter Strategic Bond has a clean ongoing charges figure (OCF) of 0.73 per cent.
