This week, we look at bond funds that can freely explore the entire fixed-income and currency universe in search of the best opportunities. Given that bonds, like other types of investments, can be a challenging asset class to predict, it might be a wise choice to let a team of experts decide how to position a portfolio.
Macro uncertainty regarding interest rates, monetary policy, or (geo)politics theoretically provides fertile ground for these flexible bond investors, but in practice, few manage to stand out from the herd. Although all types of bonds in this heterogeneous group have a certain degree of flexibility to adjust the portfolio over time, the degree of risk-taking can vary greatly. It is therefore important for investors to first determine the approach, goals, and benchmarks of the fund.
Go anywhere
At the last official meeting, the Fed kept monetary policy stable and stated that it needed to see better inflation prints before proceeding with rate cuts. Meanwhile, favorable numbers in the eurozone have strengthened expectations for a rate cut in June. If U.S. rates remain higher for longer, this could pressure some weak issuers in asset classes like bank loans or certain parts of the high-yield bond market. However, investors seem satisfied with their spreads for now, as long as recession risks remain limited and rate hikes do not return to the agenda.
But what is the likelihood of an upward surprise in inflation, and what if that coincides with an economic slowdown? What about developments in the Far East? The Japanese Ministry of Finance intervened in the currency markets when the yen came under further pressure. How far will it go? These are all questions that fund managers wrestle with as they balance short-term developments with long-term trends.
The bond king
One person who no longer needs to make portfolio decisions for others is bond legend Bill Gross. The former top investor at Pimco, who has made headlines more for neighbor disputes than for analyses in recent years, recently spoke plainly about bonds.
According to Gross, the days of earning both income and price appreciation from bonds are over. In other words, total return or core-plus strategies like the Pimco Total Return fund he created in the 1980s and managed until 2014 are outdated, and investors would do well to steer clear of bonds. The 80-year-old sees higher yields on 10-year U.S. Treasuries on the horizon because the U.S. government is taking on more debt to grow the economy. More supply means higher interest rates, according to Gross, and these have a negative impact on the price of existing bonds. He does not believe in the scenario of 2% to 3% inflation and rate cuts.
Jeffrey Gundlach, the other bond king, is more optimistic than Gross and expects a single rate cut in the second half of 2024. According to the founder of DoubleLine, higher for longer without a rate hike is a good environment for investors. Gundlach believes you can achieve quite good returns by investing in fixed-income securities that are not too risky.
Various Morningstar categories
Although Total Return funds like those from Pimco discussed above or the Loomis Sayles U.S. Core Plus Bond Fund can also be managed dynamically, Morningstar classifies them in the diversified, not the flexible bond categories. These funds primarily invest in investment-grade corporate and government bonds, do not focus on a single sector, but do have a currency focus such as euros or dollars, investing in euro/dollar bonds or bonds hedged against currency risk.
Global flexible bond funds, on the other hand, have the flexibility to invest in a broad range of bonds, often taking on considerable risk, such as in high-yield or emerging-market bonds. These funds can trade in foreign currencies as part of their investment strategy and make extensive use of derivatives and long and short positions.
M&G (Lux) Global Macro Bond fund
Strategies that prominently appear on Morningstar’s radar are deemed by fund analysts to have a strong management team and a robust investment process, or they receive these qualifications based on an algorithm that evaluates investment funds using the same framework. In this article, we highlight a fund that meets these criteria and is followed by Morningstar analysts but has had a tougher time in recent years.
The M&G (Lux) Global Macro Bond fund fits the profile of a flexible bond fund. The willingness and ability of Jim Leaviss to take positions across the entire fixed-income universe make this fund a strong option for investors, according to Morningstar analysts, despite some difficult years. Leaviss has managed this strategy in various iterations since October 1999. He has over twenty years of experience managing bond funds, both top-down global government bond funds and bottom-up credit mandates. This combination is valuable in managing this strategy. Since January 2021, Eva Sun-Wai has been co-manager.
This go-anywhere strategy is the most flexible within M&G’s retail bond range, but within its category, it is much less aggressive than many competitors. For example, the allocation to developed market government bonds is higher. It can take long-short positions in global fixed-income and currency markets and can hold a negative duration position.
Leaviss has optimally used this flexibility to build a valuation-driven and long-term portfolio across interest rate, credit, and currency markets. While the focus is on long-term themes, the manager can actively trade around them, guided by his view on the market’s technical aspects. The quality of his ideas and active risk management has enabled him to add value in virtually all market segments. Since transforming from a constrained fund of funds to a flexible global macro fund in April 2009, the fund has comfortably outperformed its Morningstar Global Core Bond category index, both in absolute and risk-adjusted returns.
Thomas De fauw is a manager research analyst at Morningstar. Morningstar analyzes and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of the knowledge partners of Investment Officer.