Jon Mawby and Andy Li, co-managers of the top-quartile GLG Strategic Bond Fund, have been focusing their portfolio on the most liquid credits after it recently reached £1bn in size.
With the increasing likelihood interest rates in the US and UK may soon start to climb off record lows, the duo are expecting some assets to experience a rise in defaults when central banks tighten monetary policy.
In particular, the managers – whose fund is top quartile in the IMA Strategic Bond sector since launch three years ago, having returned 33.9% versus the peer group average of 21.5%* – remain wary about the outlook for areas such as high yield. They are therefore running a highly-liquid portfolio which aims to take advantage of a more uncertain and volatile environment.
“In terms of positioning within the fixed income universe, we continue to maintain our profile as a low-duration credit fund, focusing throughout 2014 on the financials sector, because we are wary of the potential risks facing some other areas of the market such as high yield,” Mawby said.
“While a tightening of monetary policy is usually a portent of better economic times and lower defaults and typically positive for high yield bonds, we are concerned the default rate has been artificially compressed by ultra-low interest rates for many years.
“Therefore the beginning of a return to ‘normalisation’ could actually be the catalyst for defaults to spike.”
Mawby and Li also continue to avoid certain areas of emerging market debt because the threat of tapering and rate hikes has increased the potential for interest rate volatility as absolute yields compress in the US. They have reduced their exposure to the asset class substantially during 2014.
“We see a narrow opportunity set given the headwinds arising from tapering of quantitative easing in the US and the internal challenges facing many economies within emerging markets,” Mawby said.
A key driver of returns for the fund has been the duo’s flexibility to dynamically allocate across the fixed income spectrum, helping them navigate periods of volatility, particularly in the second half of 2014.
To that end, Mawby and Li are also currently using credit derivatives to hedge the fund’s credit risk rather than relying too heavily on the smoothing effect which government bonds traditionally deliver, after falls in yields on core government debt.