Fixed income is often seen as a safety net that investors can fall back on in difficult times, but last year proved they are not as reliable as we sometimes expect, according to Nomura Global Dynamic Bond manager Dickie Hodges .
His $2.5bn fund has beat the IA Sterling Strategic Bond sector by 3.8 percentage points since launching in 2015, climbing 17.5%, yet it was unable to avoid the volatility in bond markets last year.
It was down 16.4% last year, with almost all its holdings making a negative return. Here, FE fundinfo Alpha Manager Hodges tells Trustnet why 2022 was a reminder that bonds cannot always be relied upon.
Total return of fund vs sector in 2022 and since launch
Source: FE Analytics
What is your investment strategy?
The objective of the fund is to deliver a total return coming from income and capital. We need to generate a level of income that people find reasonably attractive.
We've got a very unconstrained universe, so we have the ability to create a fund which invests in a global set of securities across all fixed income asset classes. That allow us to deliver a higher level of dividend, a higher level of yield and also generate some capital return.
The one thing we do not invest in is private credit, mortgage-backed securities or other asset-backed securities. This is differentiated to some of our peers who in some instances rely heavily on those asset classes.
What do you dislike about these investments?
I don't believe they're transparent. They're illiquid instruments and this is a daily liquidity providing fund. What I mean by that is somebody can put their money in one day and take it out the next day.
We're trying to immunise the portfolio, but in light of the shock events of 2022 with the global inflation scare and rising escalation costs for both consumers with manufacturers, everything gave negative returns in last year, ourselves included.
Nonetheless, we’re here to deliver a level of income and capital that meets expectations in an unconstrained nature, but it is our choice to avoid the more illiquid mortgage-backed and asset-backed securities.
Is there a liquidity issue with some fixed income funds?
When you have a shock to capital markets, even the most liquid asset will become illiquid. A classic demonstration of that was the UK government bond market last year when Liz Truss introduced budget expansion measures that the bond market disliked intently, essentially removing all liquidity.
Last year was a wakeup call not just for the UK, but all investors globally, that fixed income asset classes are not as sound as they have historically been.
The UK government bond market lost as much money last year as it as it had made in the previous four years, so that was a wakeup call to all investors that fixed income can be as volatile as the most riskiest assets in equity markets.
Did any of your assets generate a positive return last year?
Idiosyncratic things would have made individual returns but realistically, the majority of the returns that we delivered were negative across all asset classes.
Our currency exposure that we use to hedge currency risk delivered positive returns but every other asset class was down.
Investment grade credit was a very small negative contribution – that had double-digit negative returns on a global level but our contribution was marginally negative. UK investment grade credit lost 20% last year but for our fund it was less than 0.5%.
What was your worst performer last year?
We had exposure to local currency Russian sovereign debt, so we took a negative hit from that. The fund was down 16% in sterling terms last year and about 7% of that was from Russian exposure.
We still hold those Russian bonds because we're sanctioned by the Russian central bank. We are classed as a non-friendly country by Russia, so we're not allowed to undertake any transactions. As a result of this, we mark all of these assets at zero.
We did not expect Russia to invade Ukraine and neither did anyone else. If everybody had expected it then they would have sold all their assets before February of 2022 and nobody would have these negative returns.
What is your outlook for fixed income markets?
What's going on in the gilt market is a reflection of the uncertainty over inflation, but we see it falling quite considerably in the US and UK. Inflation is going to fall first of all in the US, possibly down to target level by the end of the year.
The UK obviously suffered considerably from the food inflation shock and it is proving to be stickier than anticipated, but we still see inflation coming closer to 5-6% by the end of the summer.
Is that more optimistic than market forecasts?
It’s become almost systemic this idea that inflation is going to remain in the UK when it's absolutely not going to remain influential in the UK.
We are slightly more optimistic about the level of that level of that inflation will fall, but there’s a lot of talk about capping food prices, which I think is very dangerous – that would encourage food prices to rise to the extent that the cap is in place.
If you put a cap on the amount that maximum prices can go up, I can categorically tell you that will lead to all prices going up by that.
What are your interests outside of fund management?
I've never had a pet in my life (I'm going to be 56 in September), so for the two years I've had my golden retriever dog he’s basically become my hobby.