In a recent discussion with RIA Channel, Neil Sun, Portfolio Manager on the BlueBay U.S. Fixed Income team, shared key insights on positioning fixed income portfolios in a time of uncertain monetary policy.
Watch time: 12 minutes, 29 seconds
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Hello, I'm Keith Black with RIA Channel, joined today by Neil Sun, a CFA Charter Holder and a Portfolio Manager for Blue Bay's U. S. Fixed Income Team. Welcome, Neil.
Thank you, Keith, and good to be here with you all.
Last couple of years, there's been a lot of volatility in the U. S. interest rate market, and fed policy is the key to that volatility. So tell us about what's been going on in the fixed income markets and how does your team deal with that on a portfolio basis?
Sure thing. So that has actually been one of the dominating themes in the fixed income market especially for the interest rate normalization part from major central banks and investors have been adjusting their risk exposures according to different projections of the full rate path.
Market reactions to Fed commons and economic datas in the U. S. tend to overshoot, and that's why we've seen increased volatility in the race market, as well as in the fixed income market in general. In our side, in the way that we manage our portfolio being long duration amidst the recent rallies, since middle of the year of 2024 really actually benefited returns.
As inflation data shows signs of easing and the U S economy actually remains in good shape. Additionally, just by our positioning, we've been holding a view of a curve steepener by actually owning the front end of the curve while selling the 30 year part of the treasury, and this trade benefited the returns of the portfolio. By doing that, the fed expectation of cutting rates will continue to depress the front end rates while the longer term yield could stay higher for longer. With inflation, premium term, premium, and additional growth premium with that U.S. economy will continue to grow. So that trade has been working out great for market participants, as well as for our portfolios.
And that's a great call because the yield curve is no longer inverted.
Exactly. That's super helpful as a portfolio constructor to have all the tools available at hand. To deploy an active and nimble way to play around different part of the curve, not just going outright long or short or betting on the direction of the yield that is going, but have the ability to actually place your bets more on the curve shape is equally important.
Now there's different parts to fixed income investing. First, you have to get the rate environment right, and then there's the issue of corporate credit spreads as well. So what's going on in the credit spread environment with spreads relatively tight? How does that impact the ability to generate returns?
Yeah, that's a good question, we've received a lot of questions saying, the market is in really, really in good shape right now, and the credit spread is near the tight of the historical range. So where do we go from there? On our side, we continue to see the potential for double digit return for the entire year of 2024, which in the strategy that we have managed that are IG focused, we have almost achieved more than half of that double digit return target. Yes, overall, it's very hard to loft the generic spread at this tight levels. This point of the year or this point of the levels, it actually pays for an active manager to outperform and to really excel in this market kind of condition.
And by that, we mean there are still a lot of pockets of opportunities in the market corner that we believe we can achieve additional excess return. So just to mention one example here: we continue to like the trade of a compression theme: by compression, meaning that we favor those bonds or a fixed income assets that trade wider to the index or wider at a spread level, and we generally believe they will continue to perform well or outperform the things or the bonds that trade at a lower spread. Asset classes in this category we could identify, for example, the subordinate financial bonds or the hybrid securities, and we believe those bonds should continue to perform very well to the remainder of 2024, and they have achieved very great results so far in 2024 already. And we just continue to hope to ride that rally till the end of 2024. So with all that said, spreads are indeed very tight, but being active and being very selective and being nimble to take the pockets of opportunities in the market really help us to achieve additional returns to continue to benefit investors.
So a lot of this interest rate volatility is coming from Fed policy and anticipations of Fed policy, and those reactions are driven by news about inflation and GDP growth, employment and so on. But, to what extent are the U. S. elections upcoming influencing interest rate volatility and your portfolio positioning?
Indeed. So generally uncertainty and anxiety from investors tend to build up leading to the election, and this will indeed have a huge impact on the way investors allocate their assets. This is a kind of a feeling, it's like the summer holiday is over and everyone is more anxious about the first day of school.
So that's exactly the same type of feeling. Although, the various type of outcomes at different party agendas will have different impact to the market. But regardless of which party takes control of the Congress, one of the policies will remain in act is that both parties policy will continue to increase the budget deficit.
By this will could mean that more supply for treasuries thereby, depressing the treasury's price, increasing the yield on the longer side, a longer end of the treasury curve. So with this, we continue to see a different curve shape and combining that with Fed cutting rate.
This could see a continuing steeping of the treasury yield curve and away from, the impact on interest rates in the credit world, we continue to favor non cyclical sectors such as healthcare, utilities. At the same time, we try to avoid those deep cyclical sectors as well as some sectors that get heavy commercial real estate exposure. Just to stay nimble and be with the right sector at this juncture of the credit cycle.
And lastly, as a money manager, as a risk taker, were always cautious about liquidity and being, investing in the liquid part of the credit spectrum pays, especially at this part of the cycle.
So the fed is looking to cut interest rates, the markets it's expecting that. What is your expectation of fed rate cuts and how has that changed over the last few months?
So the expectation for the Fed rate cuts by market participant has been shifting violently throughout the year of 2024. Just to show examples, some group of investors were calling for eight cuts in 2024 as a start of the year and then they quickly shifted our calls to, none for May. And then in July, they shifting to four cuts for 2024.
On our side, our house view has been more on the contrarian side by contrarian, that by starting of 2024, we thought at most, there could be three cuts for the entire year by our base case, it's been two cuts in 2024 and to date to this date we continue to hold this view by, we could see two to three cuts for the remainder of 2024.
And the market consensus was eight and now it's moved to two. And you've been there the whole time.
Yes, we try to tell investors or our colleagues to focus on the bigger trend, right? Zoom out a little bit from the day to day price action, zoom out a little bit from the single fact commons or the single data point to focus on the actual trends and focus on the underlying trends from the data or from the component that makes up the data. So this way you don't get washed out by the daily volatility in the market because. People could put in different probabilities for different outcomes.
It pays to focus on the fundamentals, to focus on the actual trends and to be patient, to have conviction on your trades. And sometimes it pays out nicely for investors focusing on the bigger trends.
And what's the investor view right now, right before the Fed cut start regarding fixed income, are they excited, they hesitant, and what is your team seeing?
We've actually seen an increasing interest in fixed income. This is reflected in the fund flows data. As you can see that. Fixed income has seen significant inflows in recent years. One, one part of the reason for the inflow is the total return potential for our market.
Part of that is the perspectives of lower interest rates. When interest rate goes lower, your total return increase your price increase that contribute to as most significant part of your return potential. And the second part is the demand function. Despite the volatility in interest rates or in different other markets, we continue to see strong demand, especially in the investment grade side of the asset spectrum that investors keep coming into our market to buy bonds, buy new issues.
Despite we have a heavy new issue year for 2024, the demand just outpaced the supply by so much that you can just sense the enthusiastic investors coming into the market, trying to either lock in the yield or trying to capture the total return potential in our market.
So Neil, it sounds like it's been a bond pickers market this year. You've had some good calls, both on the steepener trade and being slower than consensus on the rate on the speed of Fed rate cuts. So how's that worked out for you and for your team?
Yes, very much indeed. Despite the spread at index level has only been marginally tighter, we actually have been outperforming our benchmark meaningfully.
So yeah, actually has been a very good year for fixed income investors, as well as for the strategies that we manage. So in general for 2024, we have seen pockets of volatilities in this year, and as an investor, we believe that, you need to be positioned to take advantage of those opportunities as they arise.
This is exactly what we have been focusing on in our strategic income, as well as core plus strategies here that I help manage at Blue Bay fixed income team within RBC Global Asset Management.
Thanks for sharing with us today, Neil.
Thank you very much.
