Navigating bond market challenges


by Clive Tompkins

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Transcription of Finance News Network Interview with Antares Income Fund Portfolio Manager, Tano Pelosi
Lelde Smits:Hello I’m Lelde Smits for the Finance News Network and joining me from Antares Fixed Income is Portfolio Manager, Tano Pelosi. Tano, welcome back to FNN.
Tano Pelosi: Thank you, it’s great to be here.
Lelde Smits: Antares cover the spectrum of domestic fixed income markets. How have the Funds been performing this year, and what have been the drivers behind that performance?
Tano Pelosi: The Funds have actually performed quite strongly this year, particularly in a relative sense against the peer group. Certainly, long positioning in credit has certainly helped excess returns, particularly with a roll down and carry. And unlike previous episodes where yields have pushed up, the credit has been fairly resilient.
Lelde Smits: What do you think are the key challenges currently facing bond investors?
Tano Pelosi: We think there are three factors, three key challenges. Firstly there’s an interplay between structural factors and cyclical drivers. And what I mean by that, there is circular forces that are interplaying with the current cycle that are impacting on growth and inflation, in ways that are not particularly well understood by the market.
The second is, at what point do investors start to unwind QE (quantitative easing) trades, trades that have built up over the last six and seven years, as central banks have engaged in quantitative easing. And the third is essentially, we’re at rock bottom yields here with respect to bonds, and there is a high probability that returns will be negative going forward. So what role does bond investing play going forward?
Lelde Smits: Bond markets globally have seen a dramatic selloff over the last month, some even fear we may be at the beginning of a major bond rout. What factors in your view are responsible for the recent bond selloff?
Tano Pelosi: I think the bond rout, or at least the bond selloff has more to do with two or three factors, such as fading deflation risks, particularly as ore prices have rebounded of late; some evidence that the European economy is starting to get on more solid footings. I think positioning with respect to investing, with bond investing, has been squared up, particularly after a long period of duration build up.
And thirdly, there’s a growing recognition that bond returns are likely to see a period of negative returns, by virtue of the fact we’ve had a great stellar performance. Internal rate returns have been driven down and yields are now at rock bottom levels.
Lelde Smits: What do you see as the key risks for rates going forward?
Tano Pelosi: There’re two, basically The Fed and market positioning. One is a little harder to determine than the other. And by that I meanit’s a little bit hard to gauge, to what extent long duration has been built up over the last five/six years, as a result of QE trades. But we can get a better guide or gauge on when The Fed will engage a lift off, with rates. But what’s not so clear is how the bond market react, will react, once we have lift-off in rates.
Lelde Smits: When do you believe the US Federal Reserve is most likely to lift rates?
Tano Pelosi: When they’re likely to lift rates and when they should, I would argue, is probably not the same thing. I think they generally acknowledge that rates are highly accommodative and by any measure, any tailor rule model,would suggest that rates are very accommodative. Even to the point where they probably should be closer to one per cent, rather than zero. So that as a backdrop, would suggest that they should move rates sooner than later, just given the starting point.
So I think the data continues to be quite weak. But the starting point with respect to rates is so, so compelling for them to lift rates soon, that we would suggest it’s going to be in the next two or three months.
Lelde Smits: What is your assessment of the current state of inflation?
Tano Pelosi: I think it’s true to say we’ve been on a rollercoaster ride with respect to inflation, shifting and oscillating between deflation risks and inflation risks. But all along, we’ve thought the risks have been binary. The economies globally are still vulnerable to external shocks, hence the deflation risks. But central banks are acting in a way that is encouraging inflation risk, reflating so to speak.
Lelde Smits: Finally Tano, earlier you touched on the more challenged nature of future bond returns. How do you think investors should view the risks surrounding future bond returns?
Tano Pelosi: Bonds still play a pivotal roll in portfolios, in the sense that they cover-off on some of the binary risks I touched on earlier, particularly if we’re not out of the woods with respect to deflation. Historically, bonds have performed tremendously in deflation periods.
Lelde Smits: Tano Pelosi, thank you for the update from Antares Fixed Income.
Tano Pelosi: It’s a pleasure.