1st February 2016
Mark Holman, CEO at TwentyFour Asset Management, discusses the company's market views and the performance of Elite Rated TwentyFour Dynamic Bond
An update on TwentyFour's market views and the performance of Elite Rated TwentyFour Dynamic Bond
Nervousness around oil, metals and mining sectors, not to mention China, has been embedded in market sentiment for a while now. But it is only since the timing of the first interest rate increase in the US was resolved that these issues became the main focus and began driving sentiment in most asset classes.
We have to conclude that these are very unusual drivers of fixed income risk, and not drivers that we think will remain in place for an extended period.
It seems that in the absence of another risk driver entering the frame, markets are looking for a bottom in the oil price before they can dismiss this factor. Determining the price bottom for a product where current prices are already significantly lower than where most producers can deliver the product does feel like guesswork.
However we do not think oil markets have fully capitulated yet and a last shift lower is entirely possible, despite what appears to be longer term good value here. As such we may have to be patient until sentiment reverses in a more meaningful manner.
The better news though is that a great deal of value has been restored to markets and investors are keen to take advantage of that; however, they are nervous about being early. Consequently, they are still waiting. As a result, we can be more confident about an eventual sharp rebound, even if we have to wait a while for it.
Our only reservation would be if this wait to hit the lows becomes protracted and eventually erodes investor confidence, because this in turn will ultimately feed into consumer confidence, which we see as an anchor of the current global recovery.
TwentyFour Dynamic Bond fund
In terms of our own fund performance, we have been fortunate over the years to have captured the majority of the larger moves and translated them into both attractive income and capital growth. More recently, the latter has been almost impossible to capture and it has been more a story of capital preservation. However, the markets we are enduring at the moment have resulted in losses, which we never feel good about and therefore wanted to explain.
Year-to-date the Dynamic Bond fund is down 1.79%. When we look at where that negative performance has come from, there is little insight to be gained as all sectors have suffered and have contributed to the decline.
Naturally, there are specific sector bonds that should be underperforming now because they have direct exposures to the core problems that the market is currently concerned with. Generally speaking, though, we have minimal exposures to these areas. Our portfolio really has traded down in sympathy, as sentiment has been so negative across the entire market.
This is not the first time that this has happened, nor will it be the last, but each time we have experienced this situation to date, it has been a buying opportunity for the market and also for our fund. We think that it will be the same this time too.
However, we are not so blinkered that we don’t consider what can happen if we are wrong.
Only last month, fixed income markets were busy worrying about the US increasing interest rates. Now, they are simultaneously worrying about how many more increases we might have in 2016 and also if we’ll have a recession. The two are usually mutually exclusive. In this economic scenario, which markets are now fearing, we will see further easing of monetary policy and further extraordinary policies from central banks. However, these policies tend to be released only after markets feel the pain and at the point of it affecting broader confidence.
In the past, the default rate has been kept artificially low. This time, with the rout in global commodities, sectors that are directly affected are going to see spikes in the default rate. Consequently the energy sector, which is c13% of the US high yield bond market, could see a default rate well in excess of 10% this year. However, the high yield loan market (which is where banks invest) has just 2% in energy, so the chances of this spreading through a well-capitalised banking system are low.
As in previous periods of post-crisis recession, we see the slowdown as being an earnings issue and — outside of the sectors mentioned — not a solvency issue. The US economy flirted in and out of recession in the years after the Great Depression and throughout that time US Treasuries maintained ultra-low yields.
Having said that, we do not have this as our base case, but even if it was, we think the portfolio would deliver what we expect and repeat what it has done in the past, albeit having endured some volatility.
The scenario that we are currently positioning for is slowing growth in China and convergence in growth between the US, UK and Europe. There will be a very slow tightening of US monetary policy as we see no more than hints of inflation in 2016. In this scenario, defaults will still pick up in the sectors described above, but the rest of the market will continue to have very low levels of default. Investors may well then enjoy some yield plus some capital gain once more.
Our strategy and tactics from here
In the short term our tactics are ones of patience as we believe that the very best opportunity is probably still ahead of us. However, picking that point in time is not going to be easy and with poor liquidity, how much can we invest at the bottom? Currently we are holding around 20% in government bonds and cash, plus some very, very short dated bonds that we could deploy when we see the best opportunity. For the rest, we are already invested and exposed to the credits and sectors that we like.
Whilst the current negative sentiment may well prevail in the short term, we think that the current market drivers are temporary.
The yields that we see on offer today are neither consistent with macro fundamentals nor the individual company fundamentals they relate to, and therefore represent good value.
The current broader market dislocations will give us the opportunity to add further yield to the portfolio and give us the potential for capital gains once again later in the year.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Mark's views are his own and do not constitute financial advice.
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