In an environment in which interest rates are historically low after eight years of expansive monetary policies, Robert Spector, who along with Pilar Gómez-Bravo and Richard Hawkins is one of the lead managers for MFS Investment Management’s MFS Meridian Funds Global Opportunistic Bond strategy, believes that there are still attractive, or relatively attractive opportunities, in which you can get good returns.
During a recent conference in Miami, the asset manager pointed out that the strategy seeks to provide consistent returns and transparency: “We want to provide investors with a fixed income experience, regardless of whether we buy high yield debt or emerging market bonds. When there is an event in the market in which investors lose appetite for risk, we don’t want this fund to behave as if it were an equity fund.”
According to Jed Koenigsberg, Institutional Portfolio Manager, who also participated in the event, some of the funds that compete in the same Morningstar category have a 30% or 40% correlation with the variable income universe. The search for predictability in returns is the differentiating characteristic of this strategy relative to competitors: “When stock prices fall, you don’t want your fixed income exposure to go down as well”.
Where are the fixed income opportunities?
The current macroeconomic environment indicates that many global regions are showing more broad-based, sustained growth, something that had not been seen since the global financial crisis. With this growth, it is very likely that rates will start to rise, albeit gradually, with very different responses depending on each of the regions.
A year ago, there was genuine concern in the markets that China, and potentially the United States, could fall into recession. Today, the risk of an impending recession is very low. While fundamentals remain strong enough to support exposure to riskier assets, MFS suggests a note of caution because of credit spread levels and higher valuations. With this scenario, MFS sees value in the higher-quality part of high-yield market and in some investment grade bonds, especially in those sectors that are increasing their leverage.
For six or nine months, the MFS Global Multi-Sector strategy managers have emphasized emerging market debt within its high-yield allocation, where they have found greater value. Investment in emerging market debt began to make sense with the noise created by President Trump when he signaled that he was going to pull the US out of certain international treaties, and with the improvement of global growth.
According to Robert Spector, although the market continues to price in the continuation of Fed rate hikes, the risks incurred in fixed income when entering a more restrictive cycle are not being correctly evaluated. By reducing its balance sheet and interest rates at the same time, the Fed is accelerating the rate at which the monetary cycle is being restricted. Although the US central bank has informed investors that it is a gradual and automatic withdrawal, Spector believes that the combination of both measures will have a material effect in the coming year.
“The balance sheet rose from US$ 7.15 billion to US$ 3 trillion, which significantly helped the economy and served as support for risk assets. A reduction in this balance sheet should have the opposite effect. In the first phases, in which the balance sheet decreases, there will be no significant changes, but later it will have a material effect. In its economic projections and ‘dot plot,’ the Fed places the rate hike for the coming years at 2.75%, but it is likely that, if the balance sheet reduction takes place, the Fed will end up at a significantly lower rate, not above 2%. Even if the Fed stops its rate hike sometime next year, it is very likely that the US yield curve will continue to flatten. At the same time, the European Central Bank has announced that it will withdraw its quantitative easing program, although it will keep interest rates in negative territory. This has already caused the yield curves in Europe to begin to steepen. We are positioning the portfolio accordingly, remaining with steep positions in Europe and with flat positions in the United States.”
For Spector and the MFS team, the sovereign debt of core European countries is widely overvalued. “Yields on German 10-year bonds are around 50 basis points. Bond yields in countries such as Austria, Finland, the Netherlands, Belgium and France keep their interest rate below 0.75%. In a world in which Europe is growing at a rate of about 2% and inflation is between 1% and 1.5%, we see a historical gap between returns and the economy. These are signs of a significant overvaluation, which is why we have eliminated most of our duration risk outside that European core, especially in the short end of the curve.”
Performance of the rest of the central banks, such as the Bank of Japan and the Bank of England, should also be considered. Put another way, global liquidity carries as much weight as the Fed’s performance in its unwinding. “This experiment has not been done before, so the final result of quantitative easing will most likely be different from the expectations that have been generated with the models of the main central banks.”
Other opportunities detected by the MFS Global Multi-Sector Fixed Income team are structured products, which represent an attractive valuation opportunity as an alternative to high-quality fixed income, where the spreads are really significant. “We have found opportunities in commercial mortgage-backed securities (CMBS) not issued by government agencies, select asset-backed securities (ABS) and collateralized loan obligations (CLOs), as well as Freddie Mac bonds, which can be a good alternative to treasury bonds. Through this type of exposure, we are able to find excellent liquidity which is roughly equivalent to that of more expensive high-quality corporate debt.
Investment philosophy and alpha sources
The MFS team emphasizes the need for a diversified approach in fixed income, especially in an environment like this one. The team’s approach is to incorporate multiple alpha sources across different categories within fixed income to find attractively valued securities, paired with active risk management. Investment opportunities vary with changes in market conditions, so they require an integrated analysis between the different fixed income disciplines at MFS: global credit, global high-yield debt, emerging market debt, collateralized securities and municipal securities and currency. Furthermore, where MFS differentiates itself is in the selection of securities. “At this point in the cycle, where spreads are so compressed, it is more important than ever to focus on debt securities that are truly appropriate for the portfolio. There are always inefficiencies along the entire cycle and throughout the cycle. And these inefficiencies are not only in the sectors, but they are in regions, in credit quality, in currencies, and in duration. Our job is to have a team that finds these inefficiencies and then integrates these multiple perspectives within the analyst team, which then leads us to finding good ideas to position within the portfolio.”
Finally, the MFS Meridian Funds Global Opportunistic Bond generates alpha from a number of sources within the portfolio: between 40% and 60% from asset allocation, between 15% and 25% from duration and country exposure, with security selection accounting for 15% to 20% and currency between 5% and 15%. “We expect to obtain returns from several sources. The most important item for us is the asset allocation, moving in and out of different sectors, but the duration, the country, and the yield curve are also very important contributors. The selection of securities is an important part of who we are, applying a bottom-up approach. We hope that this is a determining factor that drives performance,” concludes Spector.