“Although downside risks have risen, global growth should remain resilient, with aggressive central bank easing – especially by the US Federal Reserve and European Central Bank – designed to truncate downside risks, including the persisting US-China trade dispute,” Amanda Stitt, managing director and head of fixed income at product specialist group at Legg Mason Global Asset Management, told a media roundtable earlier this week.
Legg Mason is finding demand for three broad types of fixed income products. First, structured products that generate yields as high as 7% with low volatility, but restricted liquidity, such as asset-backed securities. Second, income funds that also prioritise capital preservation for cautious clients. Finally, unconstrained bond funds that are uncorrelated to equities markets.
The $6.9bn Legg Mason Western Asset Macro Opportunities Bond Fund (which is not authorised for sale to Hong Kong and Singapore retail investors) fits into the third classification, and its broad mandate means that its team of portfolio managers has almost unfettered licence to implement its preferences.
“Basically, it has adopted a barbell strategy,” said Stitt.
“Half the portfolio is allocated to high yield bonds and carry positions, and the other half is invested in 20-year US Treasuries. The high conviction, riskier exposure is mitigated by the security of long duration government bonds that might also rally further if – against our forecasts – the US economy should slide into a recession.
“Besides, US Treasuries are among the few top quality government bonds that pay a positive yield these days. There is as much as $12.9trn of outstanding debt with negative yields ”
The fund’s emerging market currency exposure included, in descending order, Brazil (8.54%), Russia (7.24%), Mexico (6.79%), India (5.15%), Argentina (3.36%), Indonesia (2.23%) and Colombia (1.27%), according to its most recent fact sheet.
The strategy has generated a cumulative three-year return of 12%, twice the return of its global fixed income sector average, although at the expense of greater volatility (5.64% compared with 3.275%).
The risk-on positions are predicated on the benign actions of central banks in recent years to prevent a full-blown recession.
In the three mini-recessions – 2012, 2016, 2018 – since the start of this decade, a monetary policy response by central banks has been the catalyst for recovery, according to Stitt.
“This is likely to happen again, so credit spread products should prove superior to US Treasuries and other developed market sovereign bonds, and local currency emerging markets bonds, though volatile, should outperform,” she argued.
Stitt’s analysis of the 25 largest US BBB-rated corporate issuers found that the management of all except three of them are either reducing leverage or keeping it stable. Meanwhile default rates are below the long-term average and there is little supply of new issuance expected during the rest of the year.
“All these factors are supportive of US credit,” said Stitt.
Meanwhile, emerging market domestic bond valuations “look attractive both on a historical basis and relative to developed markets”.
The average spread differential is 480 basis points (bps), compared with 450bps in the first half of 2018, and 350bps in 2013 – although it widened to 550bps at the start of 2016’s global economic slowdown, according to JP Morgan data.
In fact, the real yield (that is, nominal yields adjusted for inflation) differential between emerging markets and developed markets perhaps provides a more persuasive argument. The difference is now 250bps, less than the 320bps reached during the 2018 market sell-off, but wider than any time between 2006 and 2016, according to Bloomberg data.
Legg Mason Western Asset Macro Opportunities Bond Fund compared with sector average
3-year cumulative return
|Annualised return||Annualised volatility||
Source: FE Analytics. Data in US dollars, 5 Septmber 2016 – 5 September 2019 (no specified benchmark index)
Legg Mason Western Asset Macro Opportunities Bond Fund vs sector average