High levels of debt, ageing populations and income inequality are likely to make ‘normalisation’ of interest rates a fraught process for central banks, according to Fidelity International’s Sajiv Vaid, who warns investors to reassess how they think about fixed income.
Vaid, who manages the £3.9bn Fidelity Moneybuilder Income fund alongside FE Alpha Manager Ian Spreadbury, said investors were worried about three things: inflation, interest rates and valuations.
The manager, who joined Fidelity in 2015 from Royal London Asset Management, said investors will have to get used to lower levels of returns than they have become accustomed to in recent years.
Performance of indices over 10yrs
Source: FE Analytics
“While I have some sympathy [with investor concerns], returns going forwards – of all risk assets, not just fixed income – are going to be much more modest than recorded over the past few years,” he said.
“Given that returns are likely to be lower why should you hold bonds? I think it comes back to one main driver: the role of bonds and fixed income as a clear diversifier to equities by its low correlation.
“That correlation in the last few months may have broken down and is more positive, but if you look at the longer-term role of fixed income as a diversifier [the correlation] has clearly been negative.”
More recently investors have shown greater interest in passive bond vehicles, which Vaid said he understood from a cost perspective.
However, the Fidelity manager said the ability to react quickly and take contrarian positions should pay off during bouts of volatility in markets as seen at the start of the year.
“I think this is an ideal time for active managers to show their skill set,” he said. “We have a structural view, which hasn’t changed despite all the noise coming back from central banks. We’re very much in a lower growth, low inflation environment.
“There will be periods when markets will test the resolve of that and I think we have gone through that process and are [still] going through that now.”
The Fidelity manager said the reason behind its structural view were threefold: growing debt issue, ageing demographics and income inequality.
“Those are the reasons it’s going to be very hard to talk to about ‘normalisation’ of policy, it’s going to be very hard to think about elevated interest rates because all this has an impact on the global debt,” he explained.
It is right to be more cautious about risk-asset investing, Vaid said, in an environment where central banks are likely to be less supportive of markets as quantitative easing (QE) programmes – which have buoyed markets in the decade since the global financial crisis – are withdrawn.
Indeed, the Fidelity manager said previous investor assumptions about the economy and markets – including the expectation of lower volatility, strengthening GDP and a benign backdrop – had been challenged this year.
Vaid noted that yields on US, UK and European government bonds had more recently reached similar levels to those seen during the so-called ‘taper tantrum’ in 2013.
“I’m not saying a recession is around the corner but what I would say that euphoria of global synchronised growth probably seen best of the growth and in terms of valuation and we’ve seen the tights of the year, in terms of corporate spreads,” he said.
As such, the Fidelity Moneybuilder Income fund focuses on the downside and performs better during a downturn, which hasn’t been seen in markets since the first quarter of 2016.
Indeed, the fund has lagged its peer group during the past three calendar years and is in the bottom quartile.
“When we look at our peer group, you see in terms of high yield exposure we are very much at the bottom end, we’ve capped it at 5 per cent,” he explained.
“Ultimately, when you’re buying an investment grade fund you want investment grade characteristics: you want investment grade volatility and investment grade type income.”
Similarly, the managers have limited exposure to financials despite the sector being the best performers, with Vaid noting that the fund is not benchmark-driven.
“What we are doing is constructing a portfolio that is an outcome resting on three key attributes: a good level of income, modest volatility and low correlation to equities,” he explained.
“We don’t try to skew the portfolio or be dominated by key positions by sector or individual bond level that can take you away from those attributes.”
The fund’s 18 per cent exposure to the financials sector is lower than the ICE BofA ML Euro-Sterling index benchmark 30 per cent weighting. However, the manager said its positioning reduces its exposure to what can be a volatile sector and one more correlated to equities during a downturn.
“That is one of the reasons why the fund versus its peers has somewhat lagged,” he added.
Vaid said that it skews the portfolio to more non-cyclical sector such as utilities, asset-backed bonds and bonds with some security or covenant to protect them.
“That is the best way to navigate what I think is going to be quite a tricky period for investment grade managers, in terms of you have the duration to manage the individual stock level and a lot more idiosyncratic risk,” he added.
Fidelity Moneybuilder Income is included on the FE Invest Approved List, whose analysts hold co-manager Spreadbury and the Fidelity UK fixed income team in high regard.
“This bond fund is set up to be a good diversifier to a portfolio of other assets, such as equities,” the analysts noted. “The manager has maintained his exposure to the risks that are specific to fixed-income, which paid off in a big way in 2014, but won’t always do so”
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over three years the Fidelity Moneybuilder Income fund has delivered a total return of 10.44 per cent compared with a 13.17 per cent gain for the ICE BofAML Euro-Sterling index and a 11.10 per cent return for the average IA Sterling Corporate Bond peer.
The fund has a yield of 3.22 per cent and an ongoing charges figure (OCF) of 0.56 per cent.