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Ariel Bezalel: The real reason why bond funds will continue to perform

15 July 2016

The FE Alpha Manager, who runs the Jupiter Strategic Bond fund, discusses the major headwinds facing the fixed income market as we head through the year.

By Lauren Mason,

Reporter, FE Trustnet

A drop in the velocity of money, the flattening of the US yield curve and an ageing global demographic are some of the main reasons that growth is likely to remain slow, according to Ariel Bezalel, a trend that should benefit fixed income portfolios.

The FE Alpha Manager, who runs the Jupiter Strategic Bond fund, says that there are a handful of long-term themes set to play out which could impact the number of investment opportunities across the bond market.

2016 has been a particularly volatile year for investors so far, with negative sentiment surrounding China’s slowdown and the collapse in commodity price bruising markets at the start of the year.

Dovish comments from the Federal Reserve and a steady rise in oil prices created a wave of confidence in February, causing markets to rebound.

While uncertainty in the run-up to the EU referendum then caused another market dip in June, the shock announcement of a ‘leave’ majority was followed by another rise in markets, with the FTSE 100 reaching its highest point since the start of the year.

Performance of indices in 2016

 

Source: FE Analytics

Though people are focusing on the uncertainty surrounding recent events though, Bezalel warns that there are other themes that investors should be keeping an eye on and argues that, first of all, it is important to look at the politics behind the economics.

For instance, he says that the behaviour of other EU countries following on from Brexit is likely to present itself as a longer term economic theme over the next few years.

“The opinion of the EU is somewhat divided across populations in Europe and populist parties across Europe are gaining more and more favour across populations,” Bezalel said.

Share of populist vote in last two elections across the EU

 

Source: Jupiter Asset Management

“There are only a couple of countries on the chart [above] where you can see that the popularity of populist parties has come down a bit but, in the main, I think it’s fair to say that the likes of the Five Star Movement in Italy and UKIP in the UK are gaining in popularity in many of these countries.”

When it comes to the Brexit vote itself, the manager says that data shows working class voters predominantly opted to leave while high earners voted to remain.

He says this pattern emerged because, during the economic recovery, a lot of those on low-to-medium wages have seen their real incomes either stagnate or fall over the years, while those on higher incomes have benefitted.

“I think a lot of that is also very symptomatic of QE. Quantitative easing leads to an inflation in risk assets and a lot of these risk assets are typically held by the wealthier people in society,” the manager explained.

“The rich are getting richer, the poor are getting poorer and the poor are just not enjoying much of this economic recovery.”


Over in the US, he says that the likelihood of Donald Trump becoming president has increased over recent months due to the fact that salaries as a percentage of GDP are at the lowest they have been for decades, while corporate profits as a percentage of GDP are the highest they have been in decades.

This factor, according to Bezalel, has largely contributed to friction both across the US and globally and has led to real wage growth slowing.

The manager says another point for investors to consider is that sovereign bond markets are treading unknown waters at the moment, given that almost three-quarters of developed market sovereign debt is trading at a yield below 1 per cent.

“It’s really hard to see what’s going to cause bonds yields to move higher – this doesn’t just apply to Europe, but also places like Japan and the US,” Bezalel said.

“In fact, the ECB [European Central Bank] is now running out of German government bonds to buy under current rules, so rules may well have to be flexed and that could force yields in Europe even lower.”

A long-term metric that the manager looks at in terms of government bonds and interest rates is the velocity of money, which he says has been falling continually since the turn of the millennium.

Annual monetary velocity since 1998

 

Source: Jupiter Asset Management

While he says that the likes of the US economy is in decent health, he warns that the general downward trend across the board is not good news for fixed income investors.

“In terms of what’s causing this ongoing decline in the velocity of money, I think the key reason is unproductive or counterproductive debt, I believe those are the two main reasons for the ongoing velocity and decline of money,” he explained.

“Things like the ramping up of subprime car lending in the US and the boom in student lending which is now souring, I think all of these are contributing.”

“So any kind of measures by central banks to bring consumption forward I think longer term will have a detrimental impact on economies and is likely to keep interest rates low longer term.”

One form of monetary policy that has been discussed among officials is helicopter money, whereby money is printed and distributed to members of the public in order to boost the economy.

“I think the jury is out as to whether it’s going to be effective or not and while economies are so heavily indebted, I think maybe you might get a temporary upwards economic growth as governments go out there and spend heavily on infrastructure,” Bezalel reasoned.


“But longer term, high government debt levels are likely to be somewhat of a headwind to economic growth.”

The other significant headwind that investors need to watch out for, according to the manager, is the ageing demographics across the globe.

According to his research, in fact, 2020 is likely to be the first ever year that the number of people aged 65 and over outnumber children under five.

“The bottom line is that, as that baby boomer generation tips into retirement, they typically spend significantly less,” Bezalel continued.

“Across Europe and the US where you have the consumer accounting for 60 to 70 per cent of GDP, that’s going to be quite a significant headwind to growth going forwards.”

“What this also means is that the working population are having to support more and more people who are retiring. That’s going to be quite a burden on society and also a burden on public sectors globally.”

 

Over Bezalel’s tenure, Jupiter Strategic Bond has returned 100.48 per cent compared to its sector average’s return of 54.48 per cent and its benchmark’s return of 80.68 per cent.

Performance of fund vs sector and benchmark

 

Source: FE Analytics

The fund has a clean ongoing charges figure of 0.73 per cent and yields 5.1 per cent.

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