A trend back towards monetary policy easing is likely to make it more difficult for investors to meet their income requirements, according to Nomura Asset Management’s Dickie Hodges, who said they might need to think differently with their asset allocation choices.
Hodges – manager of the $479.2m, five FE Crown-rated Nomura Global Dynamic Bond fund – said the macroeconomic backdrop mirrored that of 2009 when central banks stepped in to help shore up the global economy.
“In 2009, we had central banks intervening to be supportive to global economies and capital markets because central banks, even, have worked out after all these years that if equity markets go down so does the economy,” he said.
The FE Alpha Manager highlighted the Federal Reserve that is understood to be close to cutting interest rates by 25 basis points, which he said “is not warranted” but is, nonetheless, “semantics”.
“If you and I speak this time next year, almost certainly US interest rates are going to be at least three quarters of-to-1 per cent than they currently stand,” he explained.
It represents an ‘about-face’ in terms of growth and rate expectations 12 months ago, said Hodges.
As such, more growth-supportive central bank policy and rate cuts are making it difficult for investors to find attractive sources of income.
“We are back to the same problem which we face time and time again, which is that it is proving very difficult to generate a level of income that meets investors’ expectations,” he said.
Hodges said he has had to hunt in the unexplored areas of the fixed income space to deliver yield for investors in his strategic bond fund, which aims to deliver income and capital growth by investing principally in debt securities.
“One of the largest areas which people see have seen returns, certainly in fixed income space, has not necessarily been where you imagine,” he explained. “It hasn’t necessarily been in high yield, either US or European.
“It’s actually been in interest rates, this is government bonds or sovereign debt.”
Indeed, the Nomura manager has been continuing to find opportunities in peripheral eurozone sovereign debt.
Performance of indices YTD 
Source: FE Analytics
“Since the beginning of this year, things like Portugal government bonds – 30-year Portugal government bonds – have returned an internal rate of return around about 30 per cent. Three. Zero. This is opposed to the US, where it’s only 10 per cent,” he said.
The Nomura manager added: “Over the course of the last four or five months Italian government bond yields – 30-year yields again, the longest risk of one of the longest risk assets – the yield has gone from 3.8 per cent at the beginning of February to 2.7 per cent. 
“That’s 110 basis points lower and a 20 per cent internal rate of return.”
Indeed, one of the biggest mistakes that investors could have made this year, said Hodges (pictured), would be to allocate to other so-called high-yielding assets rather than periphery Europe sovereign bonds, which have implicit support from the European Central Bank.
In addition, income has been boosted by currency hedging, although that may come down as the Fed begins to cut interest rates.
“In US dollar terms, a 30-year Italy yields 5.5 per cent as compared to a 30-year US Treasury at 2.65 per cent; double the yield. In sterling terms, it is a yield of 4.1 per cent. That is, as opposed to a 30-year gilt yield of 1.4 per cent.
“So, all of these European sovereigns on a hedged basis are looking materially more attractive from a UK investor and also from the US investor [standpoint],” Hodges added.
However, there has been a drive to lock-in such yields by investors, which have been driving prices more recently.
Given the attractive yields on offer elsewhere, Hodges said he has moved the Nomura Global Dynamic Bond fund to the lowest level of exposure to the high yield sector historically, with around 11 per cent in global high yield assets, which reduces to 8 per cent with the hedges in place.
“I do not need high-yield [assets] to generate the levels of cash I need. It’s not that I’m negative on high yield, it’s just that I’m more positive on other areas of generating returns,” he explained.
The fund also has around 20 per cent exposure to emerging markets, although he is more selective about where he invests.
Rather than taking a broad global emerging markets exposure, Hodges has highlighted several countries where he prefers to hunt, including Egypt and Russia.
“I am very positive on things like Egypt, which has been probably the best performing emerging market from a currency perspective and also from a bond perspective over the course of the last one to two years,” said the Nomura fixed income manager.
“The currency is extremely stable, GDP growth will be close to 8 per cent: Egypt themselves are going to cut interest rates by the tune of 200-400 basis points this fiscal year. You’ve got so many positives coming out from Egypt.”
As such, the manager has put 7 per cent of the fund into Egypt.
One of the other areas that the manager is most please about is Russia, which has been out of favour from an equity perspective in recent years due to sanctions related to the Syria conflict and its annexation of Crimea.
“It yields 7.5 per cent, the currency year-to-date has been very strong against the US dollar, and even more so against the British pound. And I still see a significant further room for improvements from that perspective,” he explained.
“We’ve only got around about 2 per cent of the fund [invested there], but we’ll be looking to build up that exposure as we move forward into the future.”
In addition, around 7 per cent of the fund’s portfolio is invested in convertible bonds, which he said are very sensitive to equity markets moving higher although the manager has been taking steps to reduce that volatility.
Finally, the manager has been reducing exposure to financial debt although this is not due to any bearishness on the sector rather about controlling risk in the fund with some uncertainty in markets remaining.
Performance of fund vs sector since launch
Source: FE Analytics
Since the launch of the strategy in January 2015, it has made a total return of 17.74 per cent compared with a 15.64 per cent for the average IA Sterling Strategic Bond peer.
“In sterling terms, the gross yield on the portfolio is around about 4.6 per cent, in US dollar terms the gross yield on the fund is circa 6 per cent, in euro terms yield is around about 3.6 per cent, which compares very favourably,” Hodges concluded. “And I still see room for improvement.”
It has an ongoing charges figure of 0.75 per cent.