Navigating 2024: opportunities and strategies in fixed income

I’m Darius McDermott from FundCalibre, and today I’m delighted to be joined by Richard Dickie Hodges, who is the manager of the Nomura Global Dynamic Bond fund.

[00:12] Hi Darius. Thank you for having me.

Where are you are seeing opportunity and again, how you’re implementing it in the fund. Where can we get some positive bond returns or are we back to part one where we talked about rates and those rates that have been delayed or deferred or canceled or whatever we want to call it, that they actually now will come and then we might get some positive returns from the developed UK, Europe and United States that we’ve touched on.

[0:43] I think we have to look first and foremost at where we’ve got returns today and are they likely to continue those returns tomorrow – and I mean today, since the beginning of this year – so best performing returns we’ve seen out of asset classes have come from deeply subordinated bank debt. We call these in the fixed income world, these are called AT1s. They’re the equivalent of equity for a fixed income holder. We essentially have bank equity risk because these bonds can default. And I think some of your readers might have been aware that last year Credit Suisse, they had some deeply subordinated AT1s that were priced at 100 and they actually got wiped out to zero; they suffered a full default.

So the fact of the matter is, these asset classes deeply subordinated bank debt has already returned year to date plus 5%. And I just mentioned in context, UK gilts are minus 4%, CoCocos [Contingent Convertibles] plus 5%. So they’ve delivered strong returns. We still believe from an income perspective, these are yielding 7-8% as opposed to UK government bonds yielding 4%. So we still see we’ve got a better potential income return and capital return. And one of the reasons why they’ve delivered such strong returns is year to date European bank equity stocks have delivered a positive 20% return, and over the last 12 months, they’re almost 40% returns, some of the best returning asset classes. We still see opportunities there. If we are investing for a world which is just softer landing, interest rates get cut, inflation comes down and is manageable, economies slow but they don’t collapse, then we believe that all of these examples, some emerging markets and elsewhere will still deliver returns.

If I look at high yield. Now, what I mean by high yield, well, in the world of fixed income, we have investment grade bonds, so these are bonds that are rated BBB or higher, AAA being the highest. The fact of the matter is high yield are those bonds that are issued by companies that don’t have a very good credit rating. In fact, they have a high yield credit rating. So that’s BB going all the way down to D for default. So BB high yield has actually delivered some really exceptionally strong returns, not only this year, but last year in 2023. In fact, I would say it was the best performing asset class in 2023 in fixed income. The fact is much of those spread compression, much of that outperformance is done in our opinion.

So what we’re doing now from a dynamic perspective, we are hedging out the risk that we have a harder landing. We actually have 30% of the fund hedged which will protect it against a harder landing and sharp falls in asset prices in fixed income. We actually have some hedge on to protective equity markets <inaudible> deliver some sharp negative returns. These aren’t very expensive for the point of view of the fund. They don’t in eat into a lot of the income that we can distribute. But we do think it’s appropriate thing to do given the uncertainty that we’ve got, especially if we look at politically, and I think we’ve all seen the headlines over the last couple of days as Macron dissolving part the government and actually going for an even earlier election which has caused a fair degree of volatility in financial assets.

So we still see these sort of things, we do see asset classes in fixed income delivering, but some of the highest yielding ones have delivered a considerable amount of turn so we think there’s less capital opportunity and maybe more of an income opportunity there.

And then finally what we might expect for the second half of 2024. I know we’ve sort of touched on rates and you’ve given nice examples of some of your overseas holdings and where you’ve made some money in the first half of the year. Is fixed income a good asset class for the second half of 2024?

[5:06] Well, it all depends on your view on interest rates. If, let’s say bond interest rates remain where they are, bond yields remain where they are, that means from a fixed income perspective, you’ve still got six months worth of carry from an investment grade credit fund. That means you are probably going to generate another, let’s say 3-3.5% return, positive return, just in carry. And that will deliver positive returns year to date. With the UK and with government bond yields, and if we believe, if the market starts believing that there are going to be more than one interest rate cut this year, that is presently not priced into markets, that would lead to greater capital returns, and potentially you are looking at from here on in a 5-7% positive return in fixed income from this moment in time for the remainder of this year, plus 1-2% carry, or the income you get from holding these bonds for another six months.

I was just going to say, could you just give a, if possible, a layman’s description of what you mean by carry?

[6:20] Carry, is just like, in layman’s terms, just means income or yield. So, if a bond has 4% it means that – a total return of a bond is made up of capital return and made up of income. When I refer to carry, what I mean is just the income element, so it’s just the yield. So if a bond yields 4% on the 1st of January of this year and it yields 4% at the end of the year, then we’ve just had 4% carry. It just means that it’s a fixed income term for the income element of a fund – you get carry.

Another one we tend to use over summer months when everything tends to be benign. If you hold a fixed income portfolio, us fixed income guys will talk about clipping a coupon over the summer. You know, you are sitting there with a portfolio, not much activity historically because everyone’s on holiday; there’s not an awful lot of liquidity, so essentially you are just holding onto the positions for two months and that’s referred as clipping a coupon over the summer.

Dickie, thank you very much for your time today. Not just your views on interest rates, but also a little bit of a lesson on some of the terminology that you use on a daily basis in fixed income. Now, if you would like more information on the Nomura Global Dynamic Bond fund, please do visit FundCalibre.com.