Fund in Focus: Global Bond June 2024

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Transcript

[00:00:00] Nick Peters: Hi, my name's Nick Peters and welcome to this week's podcast. Today I'm joined by James Athey and Niall McDermott, the Co-Managers of Marlborough's Global Bond Fund. Afternoon, gentlemen.

[00:00:22] James Athey: Good afternoon, Nick.

[00:00:23] Niall McDermott: Afternoon.

[00:00:25] Nick Peters: So James, you've recently joined the team. Do you want to introduce yourself and tell us why you picked Marlborough?

[00:00:31] James Athey: Sure thing. Yeah, I'd be happy to, Nick. My name's James Athey. I've been a bond investor for many years and worked in the industry for over 20 years. Previously, I worked for Aberdeen where essentially I'd been my entire career.

[00:00:44] James Athey: Why did I choose Marlborough? I mean, there's a few reasons, really. First and foremost, the opportunity to really build out the fixed income franchise, to really build something that we can be proud of, was an incredibly exciting opportunity, particularly as Marlborough has a really long standing pedigree within global fixed income.

[00:01:04] James Athey: From a cultural perspective, I really felt that Marlborough was a perfect fit for myself. The notions of great to work with and get it done, which are cultural values that, that are really strong here at Marlborough and really the passion and optimism of our Chief Executive, Richard Goodall was infectious and it was very difficult not to, to feel excited about the journey that he wanted me to come along with.

[00:01:29] Nick Peters: Welcome and it's great to have you on board. The team are keen for investors to understand it's very much business as usual. Niall, anything to add to that?

[00:01:39] Niall McDermott: Absolutely, so James is joining at a really exciting time. He's bringing, as he's described, a wealth of experience, so delighted to have him on board, so, welcome James.

[00:01:49] Niall McDermott: I would reiterate, very much business as usual. The strategy is still seeking to be an investor's core fixed income allocation. We're still pulling the same return levers. That's rates, credit allocation, and currency, and our ethos is still the same.

[00:02:07] Niall McDermott: So that's tight risk tolerances around our benchmark, we're not sort of jumping from zero duration to 10 year duration, but rather, we're seeking to add small incremental returns that compound over time. So after all, we're very much long term investors.

[00:02:27] Nick Peters: So if we turn to market environment and current positioning, what's the team's current take on the global inflation picture?

[00:02:35] Nick Peters: Can we say that inflation's no longer a headline story?

[00:02:39] James Athey: I think it's difficult to say with a hundred percent confidence, Nick, you know, inflation obviously has been such a dramatic change over the last few years relative to what we'd been accustomed to in the eight or so years prior to that.

[00:02:55] James Athey: Ultimately, inflation really is a poorly understood concept both in terms of macroeconomics and also in terms of microeconomics. So I think it would be remiss of us to say with certainty that inflation would not rear its head again in the future.

[00:03:12] James Athey: The way that we think about inflation ultimately boils down to structural as well as cyclical drivers, so on the structural side, the longer term drivers of inflation. You have things like geopolitics, globalisation and deglobalisation, at the moment, those two are linked, deglobalisation as a result of instability in geopolitics, which is leading to these concepts of on shoring, near shoring, and friend shoring, which is a reversal of the trend that we'd seen for 20 or so years prior to that.

[00:03:45] James Athey: Demographic trends will also play a part in the inflationary process over the long term, debt and the extent of debt, but also the distribution of debt. And then the policy choices which are made around economic management, but also around that debt and how to deal with it. And ultimately the distribution of wealth, income and profits.

[00:04:06] James Athey: We would observe that there continues to be a maldistribution of those concepts, and that does play a part in the economic process and the inflationary process.

[00:04:16] James Athey: On the cyclical side, the shorter term outlook, you know, ultimately, it's about supply and demand. If we go into recession, that will be disinflationary, we would say that with a high degree of confidence. The inflation that we've experienced in recent years really was largely a function of the supply shock that we saw during and after the pandemic. That supply shock has largely passed and so we've seen a significant amount of disinflation. But due to fiscal policy and immigration in particular, we've seen demand remaining more robust, particularly in the US but elsewhere, than might have been expected, and that's allowed inflation to remain higher.

[00:04:57] James Athey: Certainly then, central banks have been comfortable, and possibly us bond investors have been comfortable as well, but we would question the sustainability of those tailwinds. So our view really is that we are in an end of cycle process, those tailwinds to demand and ultimately inflation are subsiding. Higher rates that we've seen as a result of monetary tightening will slow demand and subsequently that will slow inflation over the cyclical outlook.

[00:05:27] Nick Peters: Thank you, you brought up a lot of interesting themes there and I should point out to listeners that we're likely to dig deeper into those in future podcasts so I look forward to that.

[00:05:36] Nick Peters: That sort of central scenario that James has just painted Niall, can you explain how you positioned the fund for the base case?

[00:05:44] Niall McDermott: So, in terms of a central scenario, at the end of the day, it's not really mattering what we think should happen. What matters really is what's the implied probability, essentially what's priced into the market and where we're seeing value. So, it's very much case of the Warren Buffett quote, which is "price is what you pay, value is what you get".

[00:06:08] Niall McDermott: So, the question really becomes then, where are we now? We believe we're very much in a late cycle dynamic, we've got signs of deteriorating leading indicators, we've seen a fading strength in the US, got signs it's not quite as strong as markets at first thought, and we're expecting a bit of a continued slowdown in growth. So we want to be positioned quite defensively. One of the things we've been doing is actually reducing our credit exposure. At this point, there's a real risk of things going wrong when everyone's actually pricing in what can go right.

[00:06:53] Nick Peters: You mentioned reducing credit and credit spreads are very narrow, I think, where we are in the cycle. What are your thoughts on that?

[00:07:01] Niall McDermott: We totally agree. I think credit spreads are really quite tight, which is meaning there's quite limited upside at this point. That really necessitates us being quite selective of what we have in the portfolio. As I've mentioned, we're reducing that credit exposure.

[00:07:20] Niall McDermott: You've got default risk really rising, and what we've been wanting to do is shift upwards in quality. So we've been reducing some of the lower quality and subordinated bonds in the portfolio into those tight spreads, and this is something we'll continue to do at this late stage of the cycle.

[00:07:42] Nick Peters: And you mentioned the funds, you're moving more defensively positioned, James, you just want to explain what that means in duration terms?

[00:07:50] James Athey: Yeah, so the flip side of reducing credit beta is that we're commensurately looking to increase the duration of the portfolio. Again, that's a process which is ongoing, but as Niall described in terms of our process and our philosophy, we don't seek to make huge and dramatic changes to portfolio exposures at a single point in time. You know, we're looking for opportunities to just shift those levers more steadily and more gradually in keeping with, in line with, and in response to incoming information and the opportunities that presents in terms of market pricing and in terms of liquidity.

[00:08:28] Nick Peters: And the other lever that you have is on the FX side, you take positions in the major currencies. I've read a few articles that suggest that perhaps USD strength is coming to an end. What's the team's view on that?

[00:08:42] James Athey: Yeah, it's a really important call to get right in inactive FX space. Understand the dollar, much of what else goes on will fall naturally from that. At a very basic level, we do believe in the dollar smile framework. Simply put, that says that the dollar can outperform in really two distinct and different environments. One is very much a risk off and flight to quality environment where the US dollar's reserve status leads to it being the favoured currency to own. The other is a more pro growth, pro cyclical environment, where the US is tending to outperform the US exceptionalism. In the middle, largely, is a pro growth, pro cyclical environment, where the rest of the world is outperforming the dollar.

[00:09:28] James Athey: In terms of the dynamic we're in at the moment, the market is really hoping for and priced for a very soft landing, as Niall has described, that would be expected to be dollar negative. We probably have a greater degree of concern than the market that that will very quickly become a more traditional end of cycle recessionary environment, which would be dollar positive.

[00:09:53] James Athey: So our outlook on the dollar is a little unclear because those two competing narratives, we don't have sufficient data to feel confident one way or another, so we keep inactive FX risk relatively light while we gather more data, essentially, we do have a tactical long dollar position, just reflecting the fact that there's been a narrowing of the rate differential with treasuries versus other markets. And indeed, The US still appears to us to be the cleanest dirty shirt in the laundry, that is to say, of all the economies which are in cycle, the US is most likely to sustain solid levels of growth and inflation. What we are more significantly positioned in, however, is the Japanese Yen, isn't that right, Niall?

[00:10:45] Niall McDermott: It is indeed, yes, so, as you've described, very much in a risk off scenario, Japanese Yen is a currency which has tended to perform well in the past. Usually, you know, when the excrement hits the fan, Japanese Yen is where you want to be. So fundamentally we think it's undervalued, it's been quite beaten down on, on carry trade dynamics and interest rate differentials. We know at this point, we're quite close to cutting cycles, and as James has described, if we start to see gradual cuts in the US, Japanese Yen should perform. And if things go badly, if the US has to cut quickly, we'll see those carry trades quickly unwound, which will also benefit Japanese Yen.

[00:11:37] Niall McDermott: So we quite like its defensive attributes at this stage in the cycle and we're quite comfortable holding a small, modest overweight position in Japanese Yen.

[00:11:48] Nick Peters: Thank you very much. And there's lots of news about elections, obviously the UK elections coming up, lots of news around Trump recently as well. James, just a quick view on the impact of elections on bond markets.

[00:12:03] James Athey: Obviously we're loathed to make bold predictions about politics because it's very easy to end up with egg on your face. But it does appear that on both sides of the Atlantic, really the choices that electorates are facing is not particularly different from choices they faced up to in recent years. The differences between the parties are either very well known and fundamental or really are marginal. You know, often fiscal policy boils down to tax cuts versus spending increases, there are very few responsible fiscal conservatives left in the room. So, I'm sure we will have volatility in markets around incoming poll results and potentially as manifestos get sort of filled out and become more certain, shall we say. But ultimately, I don't expect policy to be dramatically different, regardless of election outcomes, both here and in the States.

[00:12:58] Nick Peters: Okay. James, Niall, thank you very much for your time.

[00:13:02] James Athey: Thanks, Nick.

[00:13:03] Niall McDermott: Thanks, Nick.

[00:13:04] Nick Peters: They were the Co-Managers of the Marlborough Global Bond Fund, and if you'd like to find more information out about the fund, then you can do so on our website. Thanks for joining. Goodbye.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.