For some time we have been positioning for further rate rises in 2017. If anything, the Trump victory, with its (perceived) consequences for inflation reinforces the case for the Fed to hike rates. Policy rhetoric and policy implementation, however, are not the same, and we believe that markets have already discounted much of the upward inflationary and yield pressure we will see for the time-being.
There is clearly a risk of a lurch towards more extreme politics across the European Union, with elections in major markets in 2017 and beyond. Combine this with projected “tapering” of quantitative easing by the ECB and the potential for volatility in European asset prices is clear. This said, we saw with the Greek crisis that even the more extreme parties do not necessarily have the mandate to drive their countries out of the EU. Moreover, we believe the ECB stands ready to prop up the financial system in Europe should further stresses reveal themselves.
Strategy & Positioning
Nomura Global Dynamic Bond fund performance over 1yr
Source: FE Analytics
We continue to hold some relatively small, tactical positions in government yields, notably Italy, whose yields had begun to look attractive in the run-up to the referendum vote (for which we, along with the rest of the market, expected the “no” result).
Furthermore, we continue to hold a “flattening” position in US Treasuries. We increased the size of our short position at the front end of the yield curve, so that (even when offset by the long position at the long end) we held a net negative exposure to US duration through the holiday period.
We also remain net short Australian banks via CDS contracts. This position is predicated on our belief that the Australian property market could correct sharply, and the banks’ exposure to property-related debt will result in their financial positions coming under increased pressure.
One of the most significant positions in our portfolio remains the exposure to Japanese convertible bonds. We believe the Japanese equity market has considerable upside potential in the coming months, and the convertibles market offers us an opportunity to gain capital return.
The most significant change to the overall allocation in December was a reduction in our net credit exposure. Two factors were behind the change: firstly, we were concerned that a great deal of “good news” had been priced into credit spreads – high yield spreads in particular had squeezed significantly tighter – and that the potential for a correction had increased and, secondly, lower spreads and volatility had made the pricing of options compellingly cheap. We have thus been able to maintain our underlying credit exposures, whilst putting a significant dampener on their potential volatility, without giving up significant levels of yield.
Dickie Hodges is manager of the Nomura Global Dynamic Bond fund. The views expressed above are his own and should not be taken as investment advice.