Nicolas Trindade, manager of the AXA Global Short Duration Bond Fund, expects the rise in volatility witnessed at the start of 2018 to continue into the second half of the year and as a result is adopting a cautious stance within the portfolio.
Describing 2018 so far as a “challenging year”, Trindade said a combination of liquidity being withdrawn by the global central banks and continued political and geopolitical risks, should lead to even higher volatility in the second half of the year.
“It has been a highly volatile start to the year and unfortunately we expect the second half to remain quite volatile because central banks are still hiking interest rates,” he said. “The Federal Reserve has just raised rates for the second time this year and we expect the Bank of England to hike in August this year and the ECB to end quantitative easing by the end of the year.
“In an environment where liquidity is being withdrawn and rates hiked, yields should rise further and that should put negative pressure on total returns.”
Launched a year ago, the AXA Global Short Duration Bond Fund was designed to be able to deal with situations like this, and the manager said in such conditions “fundamentals matter much more”.
“That is the big difference between 2018 and previous years,” he said. “In previous years you could have been excused not to look at fundamentals because the Fed, ECB and BoE were all buying bonds indiscriminately across the whole market.
“Now that liquidity is being withdrawn, fundamentals are going to matter much more. The issue investors have is that sometimes valuations become disconnected from the fundamentals and that creates sharp repricing.”
For Trindade the resurgence of volatility poses both opportunities and risks. From an opportunity perspective he said more volatility provides active managers with the ability to potentially buy bonds at better levels.
“However when you have more volatility you also have the risk of much bigger drawdowns and that is something we need to focus on,” he added.
“That is why I think being cautiously positioned, well diversified and focussing on downside risk is the best stance to take in your portfolio right now, because we will have opportunities to buy bonds at much better levels down the line.”
To reflect this cautiousness, Trindade said 68% of the fund’s portfolio is currently invested in investment grade bonds, while 28% is held in high yield and hard currency emerging market bonds. A neutral position would be 60% in investment grade and 30% in high yield and emerging markets combined.
In terms of the investment grade exposure, the manager said the bias is towards US investment grade, while he also likes the sterling market as well.
“The short-dated part of the US investment grade market still looks quite attractive, even after hedging costs,” Trindade said. “The sterling investment grade market tends to be cheaper than that of the euro, so we do have some exposure because it is very important to have an attractive level of carry within your portfolio.”
In such conditions, Trindade said that one of the main benefits of a short duration strategy is that it allows investors to mitigate the negative impact of rising yields.
“It also does not matter in which asset class you are invested – investment grade, high yield or emerging markets – because the short duration markets all exhibit the same characteristics, which is much lower drawdowns versus their respective all-maturity markets,” he added.
“So by going short duration you can massively reduce your drawdown experience and maximise your risk-adjusted performance, which is attractive in the current market environment.”
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