As of October 2024, the bond market continues to experience heightened volatility and fluctuating yields, especially in short-term bonds like the 2-year U.S. Treasury. The 2-year bond recently witnessed its highest weekly volatility since 2009, primarily driven by shifting monetary policies and inflation concerns. This volatility reflects the market’s sensitivity to ongoing rate hikes and broader economic uncertainties.
Meanwhile, the 10-year U.S. Treasury yield, which hit 4% in October 2023, has returned to the same level after fluctuating throughout the year. This mirrors the broader trend of rising yields, with the 10-year yield peaking above 4.8% before retreating.
It’s not despite the turbulence seen in bond markets over the past year, but because of it that there are significant opportunities for active bond investors. We believe that these conditions provide fertile ground for skilful managers to outperform. The current market is not just about weathering the storm—it’s about seizing the opportunities that come with it.
At the time of writing (22/10/2024), bond markets are reeling from the risk that the Fed won’t cut interest rates as much as expected, and the endless Fed-speak has done little to allay those fears. The Fed’s inability to remain quiet and not to finesse the markets in the direction they want them to move is irritating but, at the same time, useful. As the data often wrong-foots the world’s most influential central bank, frequently leading to flawed extrapolation, some of the most skilled bond managers can produce positive relative returns to their peers.
Why We’re Positive on Bonds
Bond fund managers have a small arsenal of tools for the first time in years. They can fully utilise duration strategies with higher interest rates and unlock potential capital growth. This marks a shift from the recent past when rates were pinned near zero, forcing many investors to move down the credit quality spectrum in search of returns. Today, however, the environment allows for more balanced, strategic decisions. Credit spreads, especially in high yield, have tightened, suggesting now is an opportune time to reconsider allocating to higher-quality fixed income assets.
We’re particularly bullish on active strategies in this environment. Skilled managers who can trade credit quality and duration, navigating through the ebbs and flows of interest rates, are well-positioned to capitalise on market dislocations.
Our Top Pick
Jonathan Golan manages one of our best-performing bond funds, the Man GLG Sterling Corporate Bond fund. His performance over the past seven years is nothing short of exceptional. Golan’s ability to consistently outperform his peers is unmatched by his tenure at Schroders and his current role at Man GLG. Under his management, the fund has achieved top percentile rankings in Sharpe and Information Ratios, with outstanding cumulative and relative performance. His approach makes this fund a core holding in our bond allocation strategy.
Active Management: The Key to Navigating 2024
For active bond fund managers, the current environment has created opportunities to “harvest alpha.” With interest rate movements driving bond price volatility, these managers have capitalised on short-term price shifts by adjusting portfolio durations and strategically selecting bond maturities.
Multi-asset managers who can nimbly adjust their exposure to duration and credit quality are well-equipped to take advantage of market shifts. For example, the 10-year U.S. Treasury yield rise above 4.8% earlier this year created opportunities for active managers to trade tactically. By using duration flexibly, these managers can mitigate risk while targeting capital growth. This active management approach has allowed them to outperform passive strategies during this turbulent period.
Opportunities – But Not Without Risk
In the global bond space, top and bottom performers are actively managed funds, highlighting the importance of manager selection in volatile markets. Given the wide dispersion in performance, it’s crucial to spread risk across several managers to ensure stability and growth.
For instance, we hold the Royal London International Government Bond, which has delivered an impressive 10% return over the past year. By contrast, some of the lowest-performing active bond funds have only seen gains of around 1%. This disparity underscores the value of diversifying among top-tier managers to capture upside potential while managing downside risks effectively.
Multi-Manager Approach to Bond Investing
We adopt a diversified multi-manager approach within the IA Corporate and Strategic Bond sectors, selecting the best active managers to drive performance. This strategy allows us to include tactical and high-conviction managers while avoiding those who merely track their benchmarks or hideout amongst their peers. We believe that holding multiple funds across these sectors ensures broader exposure and better risk management, particularly in uncertain times like these.
We also favour funds that employ a flexible approach across the fixed income spectrum. Funds like the Rathbone Ethical Bond, L&G Strategic Bond, and M&G Optimal Income stand out for their ability to adapt to the diverse range of available fixed income opportunities. These funds have consistently demonstrated flexibility in navigating credit and interest rate markets, making them ideal for the current environment.
Conclusion
In summary, while the bond market remains volatile, the opportunities for active managers to deliver outperformance have never been greater. Investors can benefit from the full range of fixed income opportunities by selecting skilled managers who can make tactical adjustments in this dynamic environment. With interest rates no longer anchored at historic lows, both duration and credit quality strategies are back on the table, offering a brighter outlook for bond investing in 2024.
Our view: During the years of low inflation and interest rates, it was tough for active managers to outperform their passive peers net of fees in absolute terms. That era has gone, and we do not expect it to return. There are numerous reasons for this, but we would highlight the worsening demographics, deglobalisation, tariffs, nationalism, and the energy transition; all feeding into higher, longer-term inflation. Ex sovereigns we have moved to active management, diversifying across managers and strategies and taking advantage of the tactical opportunities in this new era of bond investing.
This communication is designed for professional financial advisers only and is not approved for direct marketing with individual clients. These investments are not suitable for everyone, and you should obtain expert advice from a professional financial adviser. Investments are intended to be held over a medium to long term timescale, taking into account the minimum period of time designated by the risk rating of the particular fund or portfolio, although this does not provide any guarantee that your objectives will be met. Please note that the content is based on the author’s opinion and is not intended as investment advice. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the OEIC fund or discretionary fund management model portfolio is suitable and appropriate for their customer.
Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.
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