Viewpoint - TwentyFour Asset Management
Eoin Walsh and Gary Kirk of TwentyFour Asset Management discuss the effects of the US interest rate rise.
What are the key factors influencing the fixed-interest markets at the moment?
GARY KIRK: The key issue that dominated market sentiment throughout 2015 was when the US Federal Reserve would hike rates. The US federal funds rate had been at record lows for seven years and it has been nine years since it was last raised; nevertheless, over the past few weeks markets had very much priced in the recent increase.
The effect of the rates lift-off will impact not just fixed-interest markets but also foreign exchange markets, commodities, global growth rates and investor sentiment – this will become more evident over the coming months. Of course, there are other factors influencing fixed-interest markets, primarily growth momentum in China, where question marks over the transparency of growth figures have resulted in investors facing a greater challenge in obtaining clarity on the medium- and long-term outlook. The slowdown in China is adding to the decline in commodity prices which is, in turn, having a big impact on exporting countries, such as Russia and Brazil, as well as on global inflation (some would say deflation). The low oil price is affecting US corporate high-yield bonds, where some 15% of the key high-yield index relates to companies involved in oil and gas exploration and extraction.
Interest rates are expected to rise further in the US this year and begin to edge higher in the UK.
How will that affect fixed-interest markets? How are you positioning the portfolio for rate rises?
GK: The current uncertainty has caused increased volatility in fixed-interest markets, but the end of the ‘commodity super cycle’ cannot be ignored. The impact of rising rates is typically felt by government and investment grade bonds first, while the initial impact on high yield markets can be more muted. But this very much depends on whether the increase in rates is perceived as a policy error – in which case there would be an expectation that growth rates would also be negatively impacted; this would be reflected in the high-yield markets. In the portfolio, we manage our interest rate sensitivity closely to minimise the impact of rate rises on the portfolio.
One of the tools we use is interest rate swaps, which ensure that we have as much, or as little, interest rate exposure as we want. We also keep a close eye on the credit duration of the portfolio, as in times of market uncertainty, the shorter the maturity date, the less volatility there will be in bond prices.
What are the factors that make European high-yield bonds attractive right now?
GK: We run a high-conviction fund and we do not diversify the portfolio for the sake of spreading risk. We will generally not invest in a bond unless we have met the management of the company that has issued it. While interest rate rises are expected, quantitative easing in Europe only started early in 2015 and will continue at least until the end of this year, and that has important implications for high yield in Europe. The cheaper financing means it is easier for high-yield companies to finance investment opportunities, roll over their debt and put long-term financing in place. That is one of the main reasons we favour European high yield. We also like subordinated bank debt.
Eoin Walsh: Quantitative easing is also devaluing the euro against the dollar and the pound, which is making European companies more competitive. Europe is also being helped by the reduction in commodity prices, as Europe is a net commodity importer.
What are your views on the political risk across Europe which is affecting countries like Greece particularly? Does this shape your thinking on where to invest?
EW: I am not certain that the Greece issue is solved as it is difficult to see how it can keep up its debt payments in the long term. Compared to last year, though, the risk of contagion is lower.
GK: The recovery in the peripheral economies is attractive compared to core euro bond markets. We particularly like Spain because of its macroeconomic policy. There is not only structural change but growth, and employment is growing faster than in the UK. We also point to a recent paper by Jean-Claude Juncker, President of the European Commission, and four other key policymakers, setting out a 10-year roadmap for a single European treasury, which makes it clear that convergence is the aim.
How has recent volatility impacted the portfolio? Is it an opportunity or a cause for concern?
EW: No one likes volatility in their portfolio, but if we are in the transition from low to high interest rates then we will see volatility, and investors need to take a long-term view.
There has been a lot of recent comment about poor liquidity in bond markets. What does this mean, why is it a problem and how are you protecting the fund?
GK: Liquidity has been reducing because of regulations which are particularly affecting market makers and investment banks, and it will not return to pre-crisis levels. We are investing in more liquid areas such as peripheral government bonds, where there is still liquidity, and focusing on short-dated bonds. Because these have an early redemption date, they alleviate the impact of a lack of liquidity – with short credit durations there are always people looking to buy.
The opinions expressed are those of TwentyFour Asset Management and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James's Place Wealth Management.
Please be aware that past performance is not indicative of future performance. The value of an investment with St. James's Place may fall as well as rise. You may get back less than you invested. Returns on equities cannot be guaranteed.