"Like baseball, the playing field going forward will be based more upon hard work rather than artificial forces," says Aurum Funds' Iain North as he discusses the global bond market.
Many global investors will be unfamiliar with the following story, at least those outside of the US. Let us start with some background - Barry Bonds was an American baseball hero, a star in arguably America's most-loved game. For 15 years he was the mainstay of the San Francisco Giants and a 14-time All Star; he won the National League's Most Valuable Player award no less than seven times. However, the integrity of Bonds was heavily questioned (and forever tainted?) when he became the central figure in a baseball steroids scandal. He was indicted in 2007 on perjury and obstruction of justice charges relating to a case that saw Bonds' long term trainer plead guilty to conspiracy to distribute anabolic steroids and money laundering. In 2013, his first year of eligibility, Barry Bonds was omitted from baseball's Hall of Fame, along with a number of his contemporaries who played during what is now known as the 'Steroid Era' of modern baseball.
Most of you will now know where I am going with this - let us now look at the global bond market. There is no doubt around the global investor community that yields have been pushed artificially low by orchestrated and non-conventional central bank policies, especially since the financial crisis of 2008. This led to formidable gains for long-only bond investors, especially when yet more quantitative easing policies were announced in the US during periods of equity market weakness. This provided an excellent diversifier for pension portfolios and helped to smooth returns, inducing the naive portfolio manager into an everlasting fixed income coma as yields continued to grind lower.
Ben Bernanke's May 2013 'tapering' speech changed the game. Even the most placid allocator woke up to the fact that the world of continuous bond returns was coming to an end. Like baseball, the playing field going forward will be based more upon hard work rather than artificial forces and 'juice' in the system. Given the moves in yields since the middle of last year, most portfolio managers are now (more or less) aware of the mathematics of rising yields and the danger they pose to total bond returns. Despite this, many are constrained in their options of what to do in the face of climbing interest rates. Fixed income mandates have traditionally been long-biased, with contractual mandates leaving little room for flexibility despite one's fundamental outlook.
For an asset class that is supposed to be the "defensive" part of a well-diversified portfolio, such constraints and idea of benchmark-hugging seem to make little sense. Since the development of modern portfolio theory, global markets and investment strategies have come a long way. There now exists a plethora of options and alternative strategies that not only can survive a period of rising interest rates, but can thrive. One such example is that of global macro, where unconstrained managers can take both directional and relative-value views on the world's asset markets (e.g. via bond futures), while also embracing institutional-quality risk policies and infrastructure.
As more traditional investment managers continue to scramble to protect their portfolios from the onset of rising global yields, I would suggest exploring the world of proven alternative strategies and welcoming markets that are driven by more fundamental factors rather than artificial policies.
Written by Iain North, senior analyst, Aurum Funds
