Rate cuts hit global bonds

The move by central banks to mitigate the effects of the COVID-19 pandemic on the economy has led to central banks slashing rates to close to 0%. 

In the US, the Federal Reserve cut rates in an emergency meeting to 0%-0.25%, the Bank of England moved to 0.1% and Reserve Bank of Australia governor Philip Lowe cut rates to a historic low of 0.25% and indicated rates will remain at this rate for around three years. 

This has created a challenge for global bond fund managers who seek positive returns for their investors in an environment where rates are likely to be ‘lower for longer’. 

FE Analytics data found that, within the Australian Core Strategies universe, the global bond sector has 87 funds from 48 different providers and are classed as those funds which invest the majority of their assets in global fixed income.

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In writing this article, Money Management looked at the sector over the 12 months to 31 March, 2020, towards the beginning of the COVID-19 pandemic. Nevertheless, March still saw unusually strong movements in the bond markets and a rapid change in convexity. 

In the global bond sector, there was wide disparity in the range of returns achieved by funds in the sector, ranging from returns of 25.4% to losses of 29%.

Over one year to 31 March, 2020, the best-performing global fund was JCB Global Bond Unhedged which returned 25.4%. This was followed by Macquarie Enhanced Global Bond at 18.6% and GCI Diversified Income Wholesale Unhedged at 12.6%. 

In its most recent factsheet to 31 March, 2020, JCB said its global bond fund was helped by its exposure to an “Italian curve flattener” which worked when the Italian debt market was in extreme stress.

“The underlying fund’s best position was undoubtedly the Italian curve flattener which was designed to work when the Italian debt market was in extreme stress. This happened in March and the underlying fund took profit on the position,” it said.

“Another small curve flattener in the US Treasury and a slight underweight in Italy contributed positively to performance.”

Although the fund was one of the most volatile in the sector with volatility of 12.8 over one year, the third-highest in the sector, it had a Sharpe ratio of 1.84 which indicated the risk had paid off, as this was one of the best in the sector. 

“Bond markets moved in a few days in the magnitude that normally occur over one year. Hence, all active risks were scaled in to reflect the sharp rise of volatility,” its factsheet said.

Funds from Colonial First State, specifically those investing in US fixed income, also performed well over one year with three funds featuring in the top 10 of best performers. 

These were CFS High Quality US Yield at 11.6%, CFS US Short Duration High Yield at 11.4% and CFS US Select High Yield 9.1%. 

Funds in the US high yield sector had been doing well over the past 12 months as they benefitted from the US bull market where everyone was desperate for yield and there were huge inflows. However, the funds later got hit during March as they were sensitive to economic growth and experienced drawdowns. 

Since then, the Federal Reserve has indicated it would include corporate bonds and high yield bonds in its bond-buying programme, as well as government bonds, which could see these type of funds rebound. 

Looking on a quarterly basis over three months to 31 March, 2020, the best-performing global fixed income fund was also JCB Global Bond Unhedged which returned 19.4%, Macquarie Enhanced Bond at 18.2% and Ardea Diversified Bond which returned 6.3%. In total, 48 funds in the sector reported positive returns in a difficult quarter. 

Gopi Karunakaran, portfolio manager at Ardea, said the fund took a pure relative value approach to fixed income by seeking out pricing inconsistencies between bonds. 

“This means we have done well over the past year as volatile markets are the best type of market to find relative value as there are lots of flows and dislocations appearing. There has been a huge amount of turmoil in markets recently,” he said.

The worst-performing Q1 fund was SPW Global Income which lost 29.2% and Invesco Senior Secured Loans which lost 16%. These two funds were also the worst over one year with losses of 26.9% and 13.5% respectively. 

The SPW fund was the most volatile in the sector at 27 but, unlike the Jamison fund, it had a Sharpe ratio of -7. 

However, when compared to Australian bonds, global bonds have underperformed with 3% average gains over one year and losses of 1.1% over Q1. This compared to returns by the Australian bond sector of 4.5% over one year and 1.3% over the first quarter of 2020.

As to what lay ahead for the global market, this would depend on the effectiveness of central bank actions and the move away from traditional monetary policy to fiscal stimulus. 

“Bond markets have had a tailwind from central banks and this was turbocharged in February as central banks went in hard but now rates are at close to 0%, how repeatable is that? If a bond fund is based around yield then when interest rates are so low, it is hard to generate returns,” Karunakaran said.

“Secondly, for the past decade monetary policy has been the dominant policy of central banks and now there’s a big shift towards fiscal policy and all this needs to be funded by the governments issuing government bonds. 

“But this is not a good combination if bond yields are at record lows and we will see a big supply/demand battle.”

Global bond sector versus Australian bond sector performance over one year to 31 March 2020