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9629
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0|Finding opportunities in Sterling and Emerging Markets
40|Performance
108|Defining duration
228|Managing duration
299|Reducing volatility
319|Range of short duration funds
405|How can the fund help?
566|Why not use a cash fund?
629|What are the advantages of short duration?
806|Diversification
1049|Strategies
1292|Who are the funds aimed at?
Duration:
00:25:26
Recorded Date:
4 June 2013
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Transcript:
ROB BAILEY: To start the second half of the presentation today we’re going to focus on short duration. We’ve got two fund managers of our short duration funds. Damien Buchet, who manages the AXA WF Emerging Market Short Duration Bonds Fund, and Nicolas Trindade, who is the Fund Manager of the AXA Sterling Credit Short Duration Bond Fund.
I’ve put the performance data up for the AXA Sterling Credit Short Duration Bond Fund. This Fund was launched just over two years ago and has generated a pretty consistent performance return in the style that we would hope and expect from a short duration fund, as you can see from here, reflecting back on some of the earlier points about a lower volatility and a sort of steady incremental returns. Since launch, it’s delivered just over 11%, and that was in November 2010 it was launched.
There’s been a slight change in plan in that the original idea was that Amalia Nuñez would be standing up here asking questions to Damien and Nic, but unfortunately Amalia has some form of laryngitis so can’t speak. So you’re going to have to listen to me droning on for a short while and then thankfully Theo Zemek has agreed to do a tag team and she will ask the difficult questions and I think one of the great comforts you can draw from that is that she will make sure she asks both Damien and Nic some tricky questions they haven’t rehearsed.
So just starting off before we get too far into duration, actually Theo managed to embarrass me yesterday. I was standing here just practising what we were going to say, having been flustered by discovering that I was going to do this part of the presentation and she asked me to define what duration was. So naturally I’ve got a good idea what duration is, but I managed to flummox around for about five minutes and come out with an answer which didn’t impress anybody. So when you’re surrounded by a team of bond experts I thought we are better to find out an actual definition of duration, so I went straight to Wikipedia and I got this example.
So ‘the duration of financial assets that consists of fixed cash flows, for example a bond, is the weighted average of the times until those fixed cash flows are received. When an asset is considered as a function of yield, duration also measures the price sensitivity to yield, the rate of change of price with respect to yield of the percentage change in price for a parallel shift in yields’. So I took that and thought about it and in simple terms, duration reflects the sensitivity of a bond toward interest rate moves.
So if you’re worried about interest rates going up, a good way to protect you against the volatility is to shorten your duration, and I wish I’d thought of that yesterday when Theo stood up in front of everybody. At this stage also I’ve got to pay credit to our PR team, Amy Butler, because clearly realising the conference was on today, she managed to get an article on the front page of The FT talking about ‘Funds left bruised by heavy-made bond losses’. And this says: “The spike in global bond yields in May triggered heavy losses for the mutual funds that invest in fixed income, highlighting the risk for investors if interest rate rises.” So well done Amy, that’s exactly the kind of coverage we need for an event like this, and we’re going to talk about ways of protecting your portfolios in that kind of an environment.
So looking at the way we manage duration I think we take a fairly simple philosophy that the key to generating superior returns is actually compounding the current income. It’s not about capital returns so much in this space as the regular flows of coupon. So if you look at this slide that we have here, the top left hand corner shows the price return since 1997, and as you see from a price perspective, there are some pretty significant spikes upward and downward, 2008 perhaps being the most graphic example of that. But the income return here has been pretty consistent throughout.
In ’97 the income levels in this particular example are around 8%, down to about 6% now, which again I think ties up with everything we’ve heard about interest rates generally. Working that out on an annualised basis the price return since 1997 has given you pretty much zero. So the capital value change has been pretty much zero. The income return though is over 6%. And I think that’s the key for us here in managing these short duration assets. Income is the driver of performance.
So, because of the shorter duration and the lower sensitivity to rate changes, we aim to reduce the volatility, and this is the point that was being made earlier about the superior Sharpe ratios and the superior returns. So focussing on income return, reducing the volatility and maximising your risk-adjusted returns. And we’ve got a range of funds that operate in this space, and I’m just going to talk about that very briefly hoping they come up now.
There’s the investment grade area. Now there are two funds in this particular space, there’s Nic Trindade’s AXA Sterling Credit Short Duration Bond Fund, which I’ve covered already. We also run an offshore euro credit version of that Fund as well. There’s the High Yield Short Duration, now some of these hopefully you’re familiar with. The US Short Duration Fund is probably the best known of our short duration funds, it’s certainly the longest running, and we’ve got something approaching £16 billion sterling of assets in this particular area. And the most recent addition to this is the AXA WF Emerging Market Short Duration Bonds Fund, which Damien is the Fund Manager of, and you’ve got a range of yields in these products from somewhere in the region of 2% to just over 5%. So the yield levels are still pretty competitive.
So at this point, having sort of given you a brief summary of our short duration space I’m going to hand over to Theo, but before Theo joins us, Damien and Nic do you want to just join us on stage? And as I say prepare to be grilled, because Theo is now going to ask you a number of very taxing questions.
THEO ZEMEK: It’s so boring to ask the questions in the order in which they’re presented, but I’m going nonetheless kick off and say: in this environment with interest rates going up as sharply as they have done, Nic, can you tell us how your Fund can help in economic circumstances as they are?
NICOLAS TRINDADE: Well the first thing to mention is that the UK 10 year gilt yield went up by 40 basis points in the month of May. That was primarily driven by what hasbeen happening in the US, because there has been some concerns in the US that quantitative easing may be scaled down before market expectations. And so what that means, basically, is that we’ve had that rise in 10 year gilt yield by almost 40 basis points. So today the 10 year gilt yield is about 2%, but even at this level, there’s much more room for a rise in 10 year gilt yield than for a decline in yield. And so what it means is basically gilts present a negative asymmetric risk return profile, and what may happen is that if we see some more improvement in the growth or fiscal outlook in the UK or some scaling down of quantitative easing in the US earlier than expected, we may see a further rise in gilt yields. That could happen without a change in the monetary policy cycle, and that is really important to understand.
So talking a bit about duration, and Rob did an awesome job at explaining duration, what is happening is basically total return of your corporate bond fund is going to move inversely to gilt yields, and that sensitivity to a move in interest rates is measured by duration. So the higher the duration, the higher the sensitivity to your fund to a move in gilt yields. And in the UK, on average, the duration of a corporate bond fund is about 8, 8½ years, and so you will need only a 50 basis points rise in government bond yields to have your total return wiped out for the overall year. And what we’ve seen in May is 40 basis points in only one month. That had quite a tremendous impact.
So now for the Fund, the Fund I manage is the AXA Sterling Credit Short Duration Bond Fund. We have a duration of about two years, and whilst the market was down by about 2% in May, we were roughly flat on the month. That I think is a good illustration of the fact that a short duration strategy can provide some protection against a rise in government bond yields. The last point I just want to talk about on this question is the bonds we invest into for this Fund are less than five years maturity. And that means that, on average, we have about 20% of the Fund maturing each year. So if we are in an interest rate environment where we can see a gradual rise in yields then the Fund will be able to participate naturally in this higher yield environment because we have so many bonds maturing each year and each month.
THEO ZEMEK: So I’m going to give you my first non-scripted nasty question, which is that we conceived of the fFund as sort of a parking lot for times when interest rates start going up, a place where you can put your money, albeit at a lower yield, protect your capital and generate a reasonable amount of income. Why not just put it in a cash fund or put it in a money markets fund?
NICOLAS TRINDADE: Well I mean the first reason I guess is cash returns as they stand today are really, really low, and so if you sit on a lot of cash you’re not going to get a lot of returns if you just sit on cash. So that will be the first reason. And so if you’re willing to go slightly up the risk ladder and go to the next safest thing within the fixed income world, which will be short-dated corporate bonds, I think it will definitely make sense to do this allocation, because by investing in short-dated corporate bonds, you can also get some upside. And I’m thinking about 2012 for example, when the performance of the Fund was over 6½%, and so if you think of a fund which is rated A- with a duration of only two years that’s quite a good return and definitely outperform cash.
THEO ZEMEK: So Damien, your proposition on the Short Duration Emerging Market Fund is a little bit different from Nicolas’ Fund. What’s the advantage of investing in an emerging markets short duration fund in this sort of rising interest rate environment?
DAMIEN BUCHET: Well, a lot of what Nicolas said about the AXA Sterling Short Duration Bond Fund could be applied to emerging markets, and that I think was actually the novelty of that product, because it’s certainly a pioneer in this field in that we are certainly one of very few funds to propose this short duration approach in an emerging market hard currency credit context. We’ve identified some competitors in that space, but mostly proposing and targeting short duration in the local currency context. So certainly, that’s a novelty in the approach.
Similarly to other credit asset classes, we conducted exactly the same tests and we had a slide earlier looking at the composition of returns over long periods of time for the sterling market, and we found out that the same applied to emerging market hard currency debts, which means that 90% of long term returns of this asset class actually come from the compounding of income. So the price return only brings you 10% of your overall total return over the 12 year period, but in fact brings you lots more volatility.
So, clearly in an emerging market context, if you really want to benefit and gain exposure to the arguably much more positive fundamental story of emerging markets compared to developed countries, which is one of and I won’t go back extensively into that, it’s quite commonplace now, but excess growth and productivity potential and especially policy, sustainability and flexibility, something which developed markets are struggling to regain at the moment, if you really want to gain exposure to that story, then a short duration approach gives you the best that the asset class has to offer.
Another point which stands out when comparing emerging market short duration credits with their peers in the euro or the US context is certainly valuations. For that positive story (excess growth and productivity, policy sustainability and improving credit quality over the past few years), you get paid much more. So as a result, we’ve been able to construct a fairly robust portfolio, fairly diversified, because I think we hold about 100 lines in a portfolio across more than 90 different issurers across all geographical regions. For that portfolio with a BB average rating, we can extract a 5% yield at the 2.5 years duration point, which is clearly a very attractive investment opportunity.
THEO ZEMEK: Considerable diversification I should imagine as well for most UK investors who don’t have that much exposure to emerging markets.
DAMIEN BUCHET: Yes. I would say it’s probably the ideal product if you want to start investing into emerging market fixed income in that you get the advantages of being exposed to the high yields, and I should add that we have a small potential for capital gain from very limited exposure up to 15% of the Fund into local currency short duration bonds. So you get that advantage without the disagreements, which are volatility and market risk. So in fact diversification is obviously something to consider, the fact that, I think James Gledhill talked about episodes of systemic default risks, which are difficult to deal with when defaults rise across the board, across the whole asset class.
In fact, the very fact that we diversified across 25 to 30 countries means that in practice, in emerging markets we almost never have episodes of systemic default rises, because a systemic default typically applies to a typical macro situation. So it may happen that in one country or the neighbouring countries with close macro linkages, you would have peaks in default rates, that happened in Argentina, that happened in Russia back in 2008, 2009, that was the case in Middle East and Kazakh Banks, but by diversifying you actually reduce tremendously the risk of default correlation in your portfolio, so systemic rises of defaults do not happen in emerging markets.
THEO ZEMEK: Diversification is important in a single currency portfolio as well and certainly in a short duration portfolio as much as anything else. We know that your visibility on defaults is theoretically a little bit better if a bond has less time to run, but to what extent is your portfolio diversified, how many holdings are there and what are the sectors that you’re emphasising and deemphasising right now, Nic?
NICOLAS TRINDADE: Well, in the Fund we hold over 100 holdings, so the Fund is quite well diversified by issuers, but diversification is really at the core of our investment process. Being diversified by issuers is quite important, but we are also diversified by sectors and by countries and that is quite important. So we do implement active strategies within this Fund and I’m just going to talk here a bit about the liquidity, because it goes into the active strategies.
So the liquidity in the Sterling market can be challenging and the decline that we’ve seen in liquidity is structural not cyclical, so it’s not about to come back, and what it means is that basically it’s expensive to trade in the sterling credit market. And one of the great things about this Fund is that we can mitigate the cost of transacting in the sterling corporate market, because like I said earlier we have about 20% of the Fund maturing each year, which means that when we want to implement active strategies we don’t necessarily have to sell the bonds as we can just wait for the bonds to mature and then we will reinvest the proceeds into the names or the sectors that we favour - that way it’s a really cost efficient strategy from that perspective.
In terms of active strategies, in 2012 we thought that the 2 LTROs from the ECB were really a game changer, and we decided to increase our exposure to financials from about 40%, 39% to about 43%, and we increased exposure to financials over the whole year. Now going into 2013, we have decided actually to decrease our exposure to banking senior, and we decreased our exposure to financials and banking senior in particular by 3% since the beginning of the year. And that is mostly related with the EC Recovery and Resolution Directive that is supposed to be passed in June and where basically senior bank debt will be bail-in, will explicitly be part of a bail-in.
THEO ZEMEK: Damien, what are the strategies that you’re looking to emphasise in the AXA WF Emerging Markets Short Duration Bonds Fund?
DAMIEN BUCHET: Well, emerging markets are in a bit of a peculiar place at the moment, because it’s largely a US dollar denominated asset class, so as such, the asset class as a whole has been suffering from the rise in US yields although clearly the US yields are rising for the good reasons: growth is coming back to the US. Now, one thing still has to be considered this time round in this cycle, which is that the US are growing much more endogenously, for themselves, and clearly this time round this US bounce is probably less import intensive than it used to be and emerging markets are getting less traction from that US bounce.
At the same time, China has recognised the pitfalls of an anarchic development and is now trying to manage its future development in a more orderly fashion. That also means more quality, but probably less quantity. And as such it’s likely that the future development of China will be probably less commodity intensive, and I’m not even talking about that secular shift away from investment towards consumption, which will take many years to materialise, but already in terms of policy choices you just see that China is moving away from massive productive investments into more infrastructure like investments. So that has quite a few impacts in terms of commodity consumption as well.
So clearly in the past few months we’ve seen that the absolute growth levels remain still very attractive. We are talking about 4.8, 5% last year and this year, so pretty steady, we’ve seen somewhat of a loss of growth momentum, which is the second derivative of growth, which clearly raises some questions. And in terms of portfolio positioning over the past two, three months we’ve actually become a bit more conservative. We’ve actually raised the risk profile of the Fund, so from BB- three months ago we’ve moved up to BB by buying more investment grade paper. We’ve also improved the liquidity profile of the Funds, and this is the leeway that we have, because we consider both governments, quasi-sovereign and corporate credits as credits.
So we’ve been raising the share of government bonds in the portfolio knowing that government bonds are typically issued in much larger sizes and give you a liquidity advantage. So it’s been a bit of both, improving the liquidity profile, improving the credit quality. But in terms of sector positioning we have actually widened and broadened our exposure to China, which is a very large provider of corporate bonds globally, especially in the high yield space, broadened it away from pure China property, which we still like as a sector, but we thought it was a good time to take some profits and buy wider GDP plays in China, materials, retail companies. The same thing applies to Russia, which is also a big weight in the Fund, because we think there that the risk reward is actually most attractive.
We’ve lowered the exposure to the most cyclical components of the Fund, so lowered the exposure to mining and metals, to switch more to the agro-related businesses, which benefit from fairly good and stable weather conditions this year, compared to the El-Niño, La- Niña weather phenomenon which was the story last year and the year before. We think that going forward with good moonsoons in India, clearer weather patterns this year, we probably have a good time ahead for agricultural companies. So these are the main direction in the portfolio at the moment.
THEO ZEMEK: We have only a couple of minutes left, so I’m going to wind up with a question to each of you beginning with Nicolas. I guess you might be able to say for UK investors the two extremes of our short duration range, the single currency investment grade over to the multimarket with a bit of corporate thrown in your Fund. So why don’t you summarise by sa reiterating what the yield is on your Fund and what sort of investors we’re looking to appeal to and why don’t you do the same, Damien, when Nicolas has finished?
NICOLAS TRINDADE: Okay. So on our Fund, the current yield is about 1.9%, average rating of A- and the duration is about two years. So far, we’ve seen really two types of investors investing into the Fund. The first type of investor is invested in all maturities corporate bond fund. They are worried about renewed volatility, they are worried about a further rise in gilt yields, and so they’re willing to go down the risk ladder and make an allocation to our sterling credit short duration in order to get some protection against those two things. The other type of investor that we have in the Fund are sitting on a lot of cash, they’re really unhappy with the cash returns as they stand today, and so they want to make their cash work harder, and so they’ve been willing to go up the risk ladder and make an allocation to our Fund, so that’s really the two types.
THEO ZEMEK: Damien.
DAMIEN BUCHET: As I said earlier, we currently have a yield of about 5% at the 2.5, 2.6 years duration point, for a BB flat average rating in the Fund. The Fund was launched back in September last year (2012), so it has about nine months existence, it just crossed the $320million line (a few weeks ago we reached $300million), and clearly the Fund has delivered what we expected it to deliver in terms of optimal-risk return. Volatility has been kept in the 2 to 4% range as we expected on the investment portfolio, and we are sitting on flat returns of about 6½% since last September (2012), so the Fund has very much delivered what it’s meant to deliver in terms of carry. The Fund appeals to a broad range of investors, but we’ve met a lot of success with private banks. I mean people who just think in total return line just don’t want to lose their capital This resonates very well especially considering the difference of performance between our Fund and the range of full maturity funds, either in the hard or local currency universe in the past month. On average the full maturity hard currency fund experienced a drawdown of about 3½ to 4% from peak to trough last month. Our Fund limited the drawdown to a quarter of that.
So in what was a real life test since we launched the Fund.
THEO ZEMEK: Well thank you very much gentlemen and I think we’ll be moving back to Rob now. Thanks very much.
Source: AXA Investment Managers as at 30/04/2013 unless otherwise stated.
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AXA Fixed Income is an expertise of AXA Investment Managers UK Limited. Issued by AXA Investment Managers UK Limited, which is authorized and regulated by the Financial Conduct Authority in the UK. Registered in England and Wales No: 01431068. Registered Office: 7 Newgate Street, London EC1A 7NX. Telephone calls may be recorded for quality assurance purposes. 16890 06/2013
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