Fund in Focus: Global Bond
Fund in Focus: Global Bond
[00:00:00] Nick Peters: Hi, my name's Nick Peters, Investment Advisor at Marlborough Group. And for this week's podcast, we're joined by Niall McDermott. He runs the Marlborough Global Bond Fund alongside his colleague, Danny Fox, hi Niall.
[00:00:21] Niall McDermott: Hi Nick.
[00:00:22] Nick Peters: Usually we start with a pretty straightforward question. Perhaps just take us through the philosophy of the fund and the approach please.
[00:00:29] Niall McDermott: Essentially what we're offering is a conservative and highly diversified global bond exposure for fund selectors. So if you cast your minds back over the last decade or so, following the financial crisis up until COVID, this period's actually been a bit of an anomaly where rates have all moved together, lower for the last 35 years or so with cheap money and basically economies needed to be supported.
[00:00:56] Niall McDermott: So the aftermath of the COVID pandemic changed this, economies basically were impacted differently with various policy measures and in turn they all opened at different speeds .Ultimately this caused divergences to appear between economies.
[00:01:13] Niall McDermott: Bond funds have three return levers, basically, so you have your interest rate sensitivity, currency exposure, and credit exposure. With diverging economies, it's important that investors are able to consider all three of those return drivers, both for returns, but also for diversification.
[00:01:34] Niall McDermott: So basically you want to consider the full opportunity set, and the natural choice we feel to do this is in the global bond area.
[00:01:42] Niall McDermott: So fund selectors essentially have two choices, blend together funds and ETFs, or allocate to a core global bond fund.
[00:01:52] Niall McDermott: Now there are actually issues with both of these approaches. So blending actually becomes a full time job, managing the interaction of those three return factors and that's as the funds are positioned dynamically.
[00:02:06] Niall McDermott: So they're constantly moving, and that requires a constant monitoring of individual fund risk exposures and this is then further compounded when you try and blend them together. So the risk becomes that your exposures are contradictory or even compounded. So it actually becomes really difficult to ascertain where you're taking risk if you do this.
[00:02:29] Niall McDermott: With the core global bond approach, if you look at IA Global Mixed Bond Sector, it offers stability on average but individually, there's such a diverse range of funds in there, and they all have really a range of benchmarks and different approaches.
[00:02:45] Niall McDermott: What this means is the return driver's one period might actually be laggards the next and when you delve into the data and look at the performance, you get these huge divergences and that's basically depending what factors in favour at a particular point in time.
[00:03:01] Niall McDermott: What that means is choosing the right fund at the right time becomes extremely difficult. And this is essentially where we come in.
[00:03:08] Niall McDermott: So Marlborough Global Bond Fund was launched in 1987. And it was launched with a conservative approach to bond fund management and we use that same philosophy today.
[00:03:20] Niall McDermott: What we do is actually undertake the work of analysing the IA global mixed bond peer group sector for the investor. We create a proxy for the median fund position. So we provide that steady return you would want from the average of that, and then we add on risk managed active positions to generate incremental return over time.
[00:03:43] Niall McDermott: How we're doing that is essentially building a highly diversified core portfolio of buy and maintain investment grade corporate bonds, and that's in order to manage idiosyncratic issuer risk, given the asymmetric return proof of bonds.
[00:04:00] Niall McDermott: So it's quite a mouthful, put simply bonds, when you buy them, you know, the upside is the risk you're taking is all the downside.
[00:04:08] Niall McDermott: To mitigate this what we're doing is limiting individual exposures and we're buying basically a wide range of bonds across different geographies. high quality credit and duration by selecting securities from a filtered pool of well research names.
[00:04:25] Niall McDermott: This portfolio is then layered with liquid government bonds and that's in order to adjust duration and bond currency positions before then we layer FX forwards in order to actually adjust the currency position to our desired exposure.
[00:04:41] Niall McDermott: That's all taken within a conservative risk managed framework and we're obviously always taking into account this neutral peer group position.
[00:04:52] Niall McDermott: So our view overall is bonds are supposed to be boring. So we want to offer stability and diversification and offer an incremental return over time, over and above that peer group average.
[00:05:05] Niall McDermott: So we want to build that up in time and put together basically a sleep easy at night package.
[00:05:12] Nick Peters: That's clear. Thank you very much.
[00:05:14] Nick Peters: It sounds an awful lot of work for just the two of you, I see you mentioned at the start that you work alongside Danny.
[00:05:21] Nick Peters: What are the benefits of that approach rather than, you know, when you compare that to some of the larger teams that you're competing with?
[00:05:28] Niall McDermott: Sure. So there's actually quite a lot of advantages of having a smaller team. First of all, we aren't really plagued with bureaucracy in making decisions. I mean, there's definitely a case of having too many cooks in the kitchen, and you don't really want to have to assemble a small army to make any decisions.
[00:05:47] Niall McDermott: So we actually have quite a disciplined schedule of weekly meetings, but the fact that we're a small team allows us to work quite flexibly and we can adapt swiftly, basically without too much indecisiveness.
[00:06:01] Niall McDermott: We also actually benefit from interacting with the wider investment team, where we can discuss ideas, compare notes on what's happening in markets on a regular basis, and ultimately, this allows us sort of a best of both approach.
[00:06:14] Niall McDermott: We've got that flexibility to react, but we've also got the resources and expertise behind us to actually deliver what we say we're going to do. And really, if you look at the track record of the fund, it really backs that up.
[00:06:28] Nick Peters: Okay, thank you. So if we take a look now at how the fund's currently positioned, I believe in terms of duration, it's around neutral.
[00:06:36] Nick Peters: Can you just take us through the thinking behind that, please?
[00:06:40] Niall McDermott: Sure. So we've been actually earning on the side of short duration over much of the last year. Really, the question's been how high do rates go, given that central banks move towards data dependency?
[00:06:53] Niall McDermott: Now the rationale for this was as curves have been inverted, there's been less of a benefit in going longer as term premiums not really been compensating investors for the additional risks in extending duration.
[00:07:08] Niall McDermott: I'll point out that we're taking quite modest positions. We're not really trying to be too clever as ultimately we want to provide investors with the stability I mentioned earlier. So our positions, we're not looking to shoot the lights out, they're all conservative and risk managed.
[00:07:25] Niall McDermott: So, the current positioning, we've recently seen this shift where central banks look like they've reached the end of their hiking cycles.
[00:07:34] Niall McDermott: The questions switch now, not from how high do rates go, but to how long can they remain high?
[00:07:42] Niall McDermott: So in the last few weeks, we've actually seen what's been described as rate cut euphoria. It's clear to everyone that central banks have reached the end of their hiking cycles, but what isn't really clear is actually when central banks will cut rates.
[00:07:59] Niall McDermott: So we think that the market participants have got a bit ahead of themselves and there's been a bit of an overreaction. I'll stress again, we're not really trying to be too clever. We're not trying to time the market.
[00:08:10] Niall McDermott: So whilst eventually we'll be looking to move longer, we'll be wanting to do this gradually over time.
[00:08:16] Nick Peters: And I presume you mentioned earlier that you take currency positions. as well, and I presume they're smaller positions as well to reflect that conservative approach, but can you just give us a picture of how you're positioned from a currency perspective?
[00:08:29] Niall McDermott: So we manage currency two ways, firstly, through the currency of the bonds themselves, and then secondly, through an overlay of FX forwards to get our desired currency exposure.
[00:08:41] Niall McDermott: Currently, our positioning has been for weaker sterling, so we've stayed underweight there.
[00:08:46] Niall McDermott: Over the last year or so, we'd actually moved to what would be our maximum underweight sterling limit, that was mainly against the dollar, as we felt markets had moved too far. We then reduced this recently as sterling did weaken, so we took a bit of that position off, and that was before the more recent rally.
[00:09:06] Niall McDermott: So we still hold the view that's risks for the UK economy are so prevalent and the Bank of England is going to be forced to cut rates sooner. If we also throw into that mix that UK elections need to be held next year, we might also see a bit of political pressure on the Bank of England.
[00:09:25] Niall McDermott: So our view has been that the currency market was the best place. to take this position instead of through guilt markets, given that there was a risk of sort of another mini budget type reaction to the UK, where basically non domestic investors could simply divest away from the market rather than going to the guilt market as a safe haven.
[00:09:47] Niall McDermott: So currently we're still positioned underrate sterling, but we've changed that from mostly against the dollar now to more equal weighting, between the dollar and the euro and the Japanese yen.
[00:10:00] Nick Peters: And to be clear, you're just positioning major currencies only?
[00:10:04] Niall McDermott: That is correct. Yes, we're only really taking conservative positions in the major markets.
[00:10:11] Nick Peters: And just looking ahead, can you see us going back to that period of ultra low interest rates?
[00:10:16] Niall McDermott: First of all, I'd say never say never, but unless we really see economic activity fall off a proverbial cliff, then I view it as quite an unlikely scenario over the next couple ofyears at least.
[00:10:30] Niall McDermott: So what we've seen post the COVID pandemic is essentially some anchoring to the last decade of this global financial crisis lower for longer and we've seen sort of a period where, where money was just thrown at markets.
[00:10:45] Niall McDermott: The pandemic really, as I've said earlier, sort of changed the playbook. It showed that inflation, you know ,isn't defeated, it can come back. So we've essentially had a period where we've had more de-globalisation, as countries have looked more inwards for production ,that's led to more trade fragmentation. When that's then combined with what would be a political unease to reduce support for economies, especially as we go through, I think there's about 40 different country elections in the next year.
[00:11:17] Niall McDermott: There's now a lot of inflationary factors at play, and we've also got sort of resilient wages.
[00:11:23] Niall McDermott: So, inflation isn't gone, and what this means is that the natural interest rate, which is the level that basically keeps inflation at the central bank target, and also full economic employment, is now higher than it has been.
[00:11:38] Niall McDermott: Plus, the view would be that central banks will want to keep the some ammunition in the toolbox, so they only really want to cut rates in an emergency. So there's going to be a bit of hesitancy there to move to ultra low interest rates, really. And what I would say is we're more looking at a return to a more historically normal period, where our expectation would be rates remain higher for longer.
[00:12:06] Nick Peters: Okay, that's clear.
[00:12:06] Nick Peters: Thank you. And with that as the backdrop. What do you see as the market outlook? What sort of returns could we expect from bond markets over the next, say, six months or so?
[00:12:16] Niall McDermott: Yeah, I think what's fascinating at the moment is if you read all the outlooks out there for 2024,there's not really a consensus view.
[00:12:28] Niall McDermott: So what's evident from markets at the moment is a lot of optimism for rate cuts.
[00:12:34] Niall McDermott: I'm not really buying into this sort of what markets are pricing it at the moment, as you've really got to ask yourself, what incentive do central banks have to cut rates with inflation above target and growth slowing, but it's still remaining quite resilient.
[00:12:52] Niall McDermott: So I like to think of it in terms of anchoring. We've just come out of a period where central banks had initially stated inflation was transitory and they were slow to raise rates.
[00:13:04] Niall McDermott: So they won't want to prematurely cut as essentially that's their ammunition. You know, I've talked about ultra low rates for when an emergency scenario would appear.
[00:13:15] Niall McDermott: So central banks, they don't want to get rid of that, they've got an incentive to hold rates for as high as they can and ultimately, this then raises the risk that something does in fact break.
[00:13:26] Niall McDermott: You've got sort of some investors describe this as a sort of boil the frog scenario, if things gradually turn bad, investors don't really see it.
[00:13:35] Niall McDermott: You've also got then on the other side, the investors themselves who've got it wrong this year. So at the start of this year, there was calls for recessions that haven't really happened. So they've actually shifted now to being overly optimistic about soft landings and our view is really, it's a risky move to try and be too clever.
[00:13:56] Niall McDermott: So some of the themes I would expect would be spread widening in the lower quality ends of credit markets, and that's as some pricing powers eroded, with inflation cooling somewhat.
[00:14:10] Niall McDermott: We've also yet to really seethe full extent of rate rises. If central banks continue to keep rates on hold, we might see more companies struggling.
[00:14:22] Niall McDermott: For this reason, I would say there's probably a bit too much optimism at the minute for a soft landing.
[00:14:28] Niall McDermott: In terms of what we'd be positioning for, we'd be looking to move gradually longer duration, as I mentioned earlier. We'd be retaining that sterling underweight, but ultimately, we're taking modest positions.
[00:14:41] Niall McDermott: We're not looking to be too clever, we're sort of wanting to offer this conservative risk managed framework to provide investors a product that enables them to sleep easy at night.
[00:14:53] Nick Peters: Nicely summarized. Thank you very much for your time, Niall.
[00:14:56] Niall McDermott: Thanks Nick.
[00:14:58] Nick Peters: That was Niall McDermott, who comanages the Marlborough Global Bond Fund.
[00:15:03] Nick Peters: And if you'd like to get more information, then please go to our website, marlboroughgroup. com. Thank you very much. Bye bye.