In this Q&A video, Andrew Mulliner, Portfolio Manager, discusses the Janus Henderson Global Fixed Interest Total Return Fund, the drivers of performance year-to-date, as well as his outlook for fixed interest in response to a number of major trends.

Interview transcript:

What is the fund?

The Global Fixed Interest Total Return Fund (Fund) is, in its simplest terms, an unconstrained global bond fund. We look to deliver superior risk-adjusted returns through the cycle by allocating to the most attractive parts of fixed interest markets, that we can identify.

The Fund is managed by myself and Chris Diaz, both members of the Global Bonds Team. And indeed we draw on that team heavily for idea generation as well as overall market analysis. But actually, the whole purpose of this fund is really to draw upon the collective expertise of the Global Fixed Income Team here at Janus Henderson.

The core of our approach is to combine a top-down macro, strategic asset allocation decision, decided by the portfolio managers, with the sector expertise of our individual market asset class experts. It’s important for us that the Fund maintains the bond-like characteristics that many of our clients and investors look to preserve and look for when they’re combining bonds with a broader risk portfolio. To do that, we maintain interest rate duration in the portfolio at a positive level, albeit with a lot of flexibility as we manage through the economic cycle. Equally, we hedge out our currency exposure back to the base currency of the Australian dollar as a starting point to ensure that it’s bond-like volatility, not currency volatility that’s being delivered. We do take select active currency positions when we feel there is a high conviction and a high quality view to be made.

2019 has been a strong year so far for the Fund what have been the main driver of returns?

2019 has been a very strong year for Fund performance thus far, it’s really been driven by the big fall in bond yields and the fact that we’ve had a very large overweight to interest rate duration within the portfolio, skewed majoritively towards the government bond markets.

This has really been led by our view that global economic growth is likely to slow quite sharply this year. And as a result, we see central banks switch away from that hawkish bias we saw in 2018, to a much more dovish approach, lowering interest rates and seeing bond yields fall and indeed that’s come to play out.

Of course, there’s more going on than just the global economic slowdown. And obviously, one of the things we’d also expected this year was actually we would see some weakening in some of the riskier asset classes, including credit. So we’ve been taking a much more defensive approach within our credit allocations, going up in quality and really focusing on what we would consider to be defensive carry asset classes, like asset backed securities. So far, what we’ve seen is actually credit has been remarkably resilient this year, the higher yielding parts of the market that we thought would be at risk, have really actually come through reasonably well. So we maintain that defensive credit positioning, we think that global growth will continue to slow and while central banks are more attuned to the risks, we still think the cycle is being underestimated by the market. And certainly, we anticipate that still maintaining a long duration exposure within the portfolio and that defensive positioning is the right place to be for the coming six to 12 months.

Negative interest rates are becoming more and more common across Europe – does the Fund have any exposure here?

Negative rates are a fact of life now for bond investors and frankly, we don’t expect them to go away any time soon. We do have a limited exposure to some of the negative yielding assets in Europe, mostly in the government bond space, but a few corporate bonds as well.

It’s important to remember that as an Australian dollar investor investing in overseas bonds hedged back into the Australian dollar, even markets in Europe which appear to have very poor or even negative yielding outcomes actually can be quite attractive once you account for the FX hedging.

And indeed, it is the case that in markets like Spain, which we still think offer quite good value from a government bond perspective, once hedged back into the Australian dollar, they provide a significant yield premium over and above the Australian government bond curve. So whilst the face value, appearance of some of these negative rates can be quite concerning to investors, actually, there are opportunities within these markets.

Trump continues to pressure the Fed around lowering rates to stimulate the economy, where do you see the US cash rate heading?

So our expectation has been that US rates will head lower, we’ve seen 10 year yields and the longer part of the yield curve really fall dramatically this year. Really in response to the fact that global growth is slowing, there is some risk aversion out there. And people have crowded into the highest yielding safe assets they can find of which the US Treasury market is still one of them. What we haven’t really seen is a significant fall in the central bank rates in the US. The Fed have cut rates thus far, only once. And that’s really in response to the fact that still the US economy is holding up better than most others. We anticipate this will change. The Federal Reserve will be forced to cut rates a lot more than is currently expected over the coming 12 months, really in response to that weakening US economy. But what we don’t really think is it’s all about Trump. So Trump has become a problem for central bankers in terms of delivering their messages, remaining focused on the economic fundamentals and certainly it is introducing narratives into markets that would question why the Fed is doing what it’s doing, however we think the Fed is firmly focused on the economic fundamentals. The Trump messaging and news flow and Twitter feed is something of a distraction for central bankers. And actually for us, it’s not really about what Trump wants it’s really all about economic fundamentals. And that will be the thing that drives rates lower in the US.

In this low rate environment what is your outlook around performance for the Fund going forward?

Lower rates do pose a challenge to bond funds, lower yields more generally mean that the risk-adjusted total return from fixed income markets are likely to be lower in the long run than they have been in the past. That said, we believe that the economic cycle is something that you need to be keenly focused on – yields are falling in response to a slowing of that cycle. And we expect the central banks will cut rates, however, it’s a cycle, so that means in due course, we’ll probably see some better growth as central banks and governments stimulate the economies. And that can mean high yields in the future. But importantly, it also means attractive returns from some of the riskier asset classes that we’re cautious towards at the moment and those yields are still somewhat attractive to bond investors. So it’s certainly not a reason to be one hundred per cent gloomy around bonds over the longer term. We believe investing through the cycle is all about being nimble in our asset allocation and there will be opportunities to deliver attractive returns for investors as we move through the cycle. The other thing to bear in mind is that bonds aren’t there just necessarily to deliver a return for investors, they also operate within a diversifying context within the broader portfolio. And we believe in a world where inflation remains low, even in a relatively low rate environment, that diversifying quality will still continue to persist. And therefore an allocation to bonds still does make sense, especially if you’re looking to balance a portfolio of riskier assets like equities as well.

So the probability of recession has become something that a lot of investors decided to focus on quite aggressively. Certainly, for us coming into the year, we were thinking more around an economic soft patch, rather than an outright economic recession, although clearly that was a risk. What we’ve seen is that obviously the cycle has been slowing globally and it’s really been China economic slowdown-led, but it’s being aggravated now by the trade war that’s been propagated by Trump, in particular, towards China. And really, it’s that side that means the balance of risks are increasingly tilting towards a recessionary outcome and away from a more benign, slow, soft patch traditional economic cycle.

So what would make an economic recession more likely? Certainly, there are a lot of market indicators out there which suggest that a recession is becoming increasingly a likely probability. Chief among those is the bond yield curve. The fact that we’ve seen an inversion in the yield curve, which means the short-dated yields are actually higher than the longer-dated yields, is usually a good indication that investors are becoming very risk averse, very concerned. And they expect rates will have to be lower in the long run, because there will be some sort of economic recession upcoming.

But away from that, some of the other indicators are a bit more sanguine. So certainly, we’ve seen a lot of weakness in the manufacturing side of the global economy – that is in recession right now. But the services side of the economy has been much more resilient. And it’s important to remember that actually 80% of GDP is services-related. And the manufacturing side of the economy is actually quite small, especially in developed markets. So really, it comes down to the question of whether the services side of the economy will start to slow alongside the manufacturing side, or can we somehow kind of limp through this manufacturing cycle, perhaps come out the other side of it and then perhaps we’ll see very minimal job losses, which is usually the thing that basically signs off a recession. Perhaps we’ll get through this as just another manufacturing cycle, that doesn’t really have huge impact on the overall economy, in totality.

We think there are reasons to be optimistic, but really, they will come down to whether we can get this trade war resolved. There have been some signs at certain points this year that perhaps de-escalation is more likely and currently, that feels to be the case. The reality is, if we don’t have that de-escalation, it seems very likely that rather than seeing an improvement in the manufacturing side, that the weak sentiment that we see currently existing will actually permeate and manifest itself in sharp cuts in capacity, which means jobless rates and jobless rates going up. And when you see jobless rates going up, even in a small part of the economy, it tends to ripple through as the demand for services in the economy goes down and you start to see job losses pick up there as well. So that’s the real concern for us. We certainly think we’re not out of the woods, we think risks of recession have picked up. And certainly we’re looking for a significant change in the trade rhetoric to ensure that this cycle is just a cyclical slowdown and not something more worrying such as an economic recession.

 

Recorded 19 September 2019.