Last week FSA comapred two US high yield bond funds, a category which has gained more attention amid expectations for a quicker cycle of US Federal Reserve interest rate hikes than previously expected.
However, the future environment might be challenging for government bonds, said Luke Ng, FE Advisory’s senior vice president of research.
“Fixed income has been quite expensively valued, so if there is a sharp reversal of fund flows going from fixed income into equity space, that might be a concern for the bond market.”
Nevertheless, the bond yield is trending downward given the negative interest rate policies in Europe and Japan, he added.
Still, “government bonds remain a core component for portfolio construction within the fixed income asset class, as to provide capital protection,” he said. It might be more important now than ever to pick an active fund to sail through the heightening risks.
Against this backdrop, Ng provides a comparative analysis of two global government bond funds – the Templeton Global Bond Fund and the BlackRock GF Global Government Bond Fund.
Luke Ng, FE Advisory Asia’s senior vice president of research
Investment strategy
The two funds have similar benchmarks – Blackrock’s is the Citigroup World Government Bond Index and Templeton’s is the JPMorgan Global Government Bond Index. Both indices focus primarily on the developed world, Ng said.
For the benchmark indices, around 30-40% is allocated to the US, 20-25% to Japan and the remainder to European countries.
Although both funds share similar views on positive expectations for the US market, the Templeton fund deviates a lot from the benchmark, as it has for years with its unconstrained approach, he noted.
| Top country breakdown | Blackrock fund (benchmark) (%) | Top country breakdown | Templeton fund (benchmark) (%) |
| Japan | 21.92 (23.35) | Mexico | 23.07 (0) |
| US | 17.06 (33.58) | South Korea | 15 (0) |
| UK | 13.37 (5.34) | Brazil | 13.65 (0) |
| France | 8.65 (7.61) | Indonesia | 9.92 (0) |
| Italy | 6.29 (7.41) | Malaysia | 9.18 (0) |
| Germany | 5.95 (5.68) | Ukraine | 3.62 (0) |
| Cash and cash equivalants | 2.44 (0) | Cash and cash equivalants | 13.1 (0) |
Source: Fund fachsheets as of October 31
The Blackrock product invests at least two thirds of the portfolio in high quality government bonds, while lower-rated opportunities or corporate bonds can make up as much as a third of the fund.
“The fund is more aligned with the benchmark. Hence the average duration stays similar to the benchmark at around eight years.” Annualised volatility reaches only 2.8%.
“Overall, the team intends to reduce duration exposure for the US and overweight UK gilts in the expectation that the Bank of England will remain dovish amid Brexit uncertainty,” Ng continued.
The fund has the flexibility to allocate up to one-third of its holdings into lower grade or non-government bonds. For example, the fund has 11.2% in corporate bonds as of October-end.
Currency exposure is predominately US dollars.
In contrast, the Templeton fund “adopts a total return approach, where the team actively looks at value opportunities coming from yield curve, sovereign credit and currency ideas”, Ng said.
“The strategy is run independently from the benchmark and historically the composition of the fund has been enormously different from its benchmark and peers in the sector,” he continued.
The team positions the fund with extremely short average duration of -0.22 years, close to zero exposure in key developed economies including the US, Japan and European countries, close to 100% currency exposure in US dollars, with additional long exposure in selective Latin American and Asia ex-Japan currencies and negative exposure in JPY and EUR (about -45% each). At the same time, average credit rating sits at around BBB+, Ng noted.
The portfolio results from the view of “a strengthening in the US economy with increasing inflationary and wage pressures, and that tends to magnify the fundamental differences between healthier and more vulnerable economies”, he explained.
Thus the annualised volatility is also higher than the Blackrock fund at about 8%, he added.
Performance
The Templeton fund has largely underformed the past three years compared to the Blackrock fund.
“Templeton has also positioned with very low duration for some years in the expectation of a better economy, and that hurt the performance, especially when the yield curve flatten throughout the past few years,” Ng explained.
But Trump’s victory in early November has helped the fund turn around the past month.
Over a ten-year period, the Templeton fund significantly outperformed the market and the Blackrock fund, Ng added.
For the 10 years to Nov 2016, Templeton returned approximately 75% in US dollar terms, much higher than the market and Blackrock. Although the return is high, the fund experienced higher volatility than Blackrock over that period, Ng noted.
