AXA Investment Managers’ Nick Hayes cut duration on his strategic bond fund at the start of the year as his nervousness over a financial shock rose.
The Citywire A-rated manager believes bond markets are in a scenario where risk-on, supported by forward guidance, remains the top trade in the hunt for yield. He struggles to see high yield delivering a total return of much more than 6% this year.
‘The economic environment is seen as gently positive and there has been a huge issuance of investment grade bonds, which is outstripping demand,’ he said an interview with Wealth Manager shortly before the recent correction in martkets.
‘The more this happens, the more concerned I get. Credit spreads are at their tightest level in five years and issuance has become speculative.’
Hayes fears an unpredictable event could cause a market correction where spreads widen and equities fall.
‘This may be earnings disappointments, or a political event in Europe,’ he explained. ‘This could cause people to ask why they are buying high yield, resulting in a repricing of risk and a rally in core government bond yields as people go for safe haven assets.’
Shock not priced in
He does not think bond markets are pricing in the risk of a shock and has positioned his portfolio more defensively. He has cut the fund’s duration from 4.5 years at the end of last year to around 2.75 years.
Hayes has bought short duration BB rated paper on a yield of between 2.5% to 3%, with maturity from six to 18 months. ‘We are as cautious as we can be and acknowledge that yields are low and the potential for attractive gains is not there. The risk reward is not in favour of adding more risk at the moment,’ he said.
‘Bonds with shorter maturity are not going to move in price if we get that shock. My biggest fear is buying risk at the wrong price and lots of people are doing that at the moment, which is why we’re more cautious. If spreads get higher we will look to take advantage.’
At least one fixed income sub-sector has delivered a minimum annualised return of 10% in the past 11 years, with high yield accounting for this return in four of the last five. But Hayes accepts this trend is unlikely to last.
‘You can’t have a continuous rally in high yield like we’ve had in the last few years. There is only so far credit spreads can tighten,’ he said.
In another defensive move, he has increased his cash weighting from 2% at the end of 2013 to 6% and he anticipates this rising to around 10% before he redeploys capital.
The fund is currently yielding 4% and he accepts his more defensive approach is likely to result in a marginal fall in income. ‘We are happy to take risk off to effectively protect capital and after a shock event we can try to get some of that yield back.’
However, Hayes is not indiscriminately bearish, seeing emerging market debt (EMD) as one area where decent value can be found after a difficult 2013.
His exposure to the region is around 7% and he predicts this will go through 10% as he continues to reduce exposure to high yield developed market debt.
‘Following the repricing of emerging market debt last year, valuations are much more attractive and look more exciting than developed markets,’ he said.
EMD gaining sophistication
He notes investors are starting to recognise the increased sophistication of the EMD market, which he feels got a little lost in the hunt for yield following the credit crunch.
‘People have realised that one of the key attractions to emerging markets is that it is a number of mini-bond classes rather than a single asset class. It is possible to get high quality long duration in investment grade and sovereigns.
‘There are so many types of assets in emerging market debt and I think over the last year investors have started to realise this and you are slowly starting to see more differentiation in the region.’
Like many of his peers, Hayes is concerned about the impact that quantitative easing (QE) tapering will have on asset prices.
‘There are going to be problems coming out of a QE environment and I don’t think this has been priced in. It is certainly not going to be a smooth transition.’
The sterling hedged share class of the AXA WF Funds Global Strategic Bond fund, which has $226.7 million (£137.8 million) in assets, has returned 12.3% since its launch in May 2012.