Overview

  • A barrage of discordant notes is unsettling fixed income markets
  • Second guessing the path of inflation is becoming difficult
  • Markets are closely watching central bank statements for policy tightening

Aiming for perfect harmony

The fixed-income world faces a confusing cacophony of challenges. Striking the right keys at the right time is crucial to avoid discord. This calls for handing over the baton to the expert.

Generating alpha is all about hitting the right keys

The fixed income market is currently facing a hubbub of issues. Historically low yields, inflation worries, ultra-tight credit spreads, fears of stimulus unwinding, liquidity premium, concerns of a haphazard recovery and the emergence of new variants of coronavirus are just some of them.

 

The attempts by central banks to contain the effects of the upheaval caused by the coronavirus pandemic since early 2020 have depressed yields further. Indeed, the market value of negative yielding debt, both sovereign and corporate, almost equals the size of China’s GDP*. In the credit market, spreads have tightened significantly, resulting in elevated valuations.

 

Everyone is trying to second guess the trajectory of inflation and how soon policy makers will begin to tighten interest rates. It’s well known that policy makers have tried to rekindle inflation since the financial crisis more than a decade ago, with little success. In that world of falling yields and low volatility, economic outcomes were poor, as central bank liquidity flowed directly into financial assets.

 

Smooth transition

But now governments have joined hands with central banks in efforts to boost growth and inflation, giving some heft to the initiative. The rapid vaccination rate achieved in major economic regions of the world has instilled some optimism about recovery. At the same time, supply bottlenecks and labour shortages are creating concerns on the inflation front.

 

It’s a confusing picture. Even US Federal Reserve officials have been giving off mixed signals. The key question is whether the uptick is transitory, or sticky. Any indication of imminent tightening by central banks or withdrawal of stimulus by governments could bring back memories of the famed `taper tantrum’ of 2013. Indeed, some would argue that the post-pandemic scenario is a perfect recipe for heightened volatility. Liquidity, or the ability to freely trade assets, may become a casualty.

 

To exploit this complex environment and preserve harmony, management of assets through the transition needs to be just right. That calls for specialised skill, deep experience, and developed expertise. A proven track record of generating alpha amid low yields and increased volatility is crucial. Whether you are seeking to generate income in the face of low yields, are concerned about liquidity in parts of the bond market, are nervous about the potential for a spike in inflation, or simply want to outsource your key fixed income asset allocation decisions, at Jupiter, we believe we have what it takes to address these key concerns. We call this human advantage ‘the value of active minds.’

 

*The total market value of negative-yielding debt worldwide was US$14.6 trillion as at 17 September 2021, according to Bloomberg. The size of China’s GDP at the end of 2020 was $14.7 trillion, according to World Bank data.

Capabilities

Solutions

  • Investors confront a host of challenging questions amid the pandemic
  • Balancing risk and reward requires skill, expertise, and in-depth knowledge
  • Safety is as important as generating yield in this tricky environment

Bond harmony is finding the perfect composition

How do you position for reflation? What happens if an expected economic recovery is delayed? How do you balance risk and reward? How do you determine how much of an expected economic change is already priced in? Will interest rates remain lower for longer or will the central banks give a jolt? What is a realistic outlook for the various bond sub-asset classes? These are all challenging questions for fixed income investors.

 

Envisioning the long-term market trend is as important as finding returns in the short term. A right mix of assets is essential. Instruments considered less risky, such as sovereign bonds and investment grade corporate debt, may inevitably offer lower yields. On the other hand, higher yielding bonds may carry a greater risk of illiquidity and default. Hedging such risks through derivatives may also entail costs, while following the herd mentality could prove costly if everyone runs for the exit at the same time.

 

To navigate this complex world, an in-depth understanding of macroeconomic factors such as ageing demographics is as important as studying flows, reading central bank liquidity data and keeping an eye on the vagaries of the currency markets. Understanding what the sheer level of global indebtedness means for inflation and growth is equally important. In this environment, we believe that flexibility and nimbleness are likely to be key to achieving desirable outcomes in fixed income portfolios.

Jupiter offers several potential ‘one-stop’ solutions for investors seeking expertise to allocate their assets dynamically between the various fixed income sub-asset classes as market conditions and the economic environment change over time. Both the Jupiter Dynamic Bond Fund and the Jupiter Strategic Absolute Return Bond Fund (SARB) take an active and flexible approach to investments.


Both the strategies also use similar techniques to study macroeconomic trends to analyse the potential outcome for the global economy. However, the two strategies express that analysis in very different ways. The Dynamic Bond strategy expresses many of those themes by choosing the right sectors of the economy to be exposed to, while also setting the best duration overlay to reflect that analysis. The fund uses only limited foreign exchange exposure. SARB uses limited credit exposure and looks to express its macro views mainly through interest rate, FX and sovereign exposure.

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Solutions

  • Sticky or not, that’s the question, as inflation rears its head
  • Supply bottlenecks, resurgent demand quicken inflation, confounding markets

Staying in tune with inflation: managing spikes, fading returns

The pace of price increases in the economy has a big impact on fixed income markets as it dictates the underlying value of the assets as well as real (above inflationary) returns generated for investors. Staying in tune with the direction of inflation is therefore crucial. Central banks around the world have been engaged in a sustained effort to spur inflation since the global financial crisis more than a decade ago.

 

Major central banks such as the US Federal Reserve, the European Central Bank and the Bank of England have stepped up their game to boost economic growth as the Covid-19 pandemic continues to disrupt normal life. Governments have also elevated spending and are unlikely to withdraw their support anytime soon as the livelihoods of the most vulnerable are the most exposed to the coronavirus.

 

While the post-financial crisis era was marked by low growth and low inflation, the additional backing from governments this time around has evoked some optimism about growth. But talk of reflation has caused nervousness among some fixed income investors. Is inflation transitory or persistent? That’s the key question many want answered. While a reflationary environment might well signal brighter times ahead for the global economy, it could prove rather challenging for many traditional fixed income investment strategies.

We believe that staying nimble and flexible will be the key to generating strong risk-adjusted returns, growing capital and mitigating risk through the interest-rate, credit and economic cycles. Jupiter’s Dynamic Bond strategy takes a high-conviction, go-anywhere approach, enabling it to adapt the portfolio as markets and the environment evolve. Meanwhile, our Strategic Absolute Return Bond strategy takes a highly flexible approach to investing across the fixed income market spectrum, constantly reshaping itself as the environment changes, with the ability to express outright negative views on duration.

Jupiter Dynamic Bond: Rotation and diversification

Jupiter Dynamic Bond: Rotation and diversification
For illustrative purposes only.

The fund manager has the power to use derivatives for efficient portfolio management only, not for investment purposes. Source: Jupiter. as at 30.06.21. DM includes all Western European countries. *Includes interest rate futures. Asset allocation includes derivatives’ exposure. 

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Solutions

  • Coronavirus lockdown brings back memories of market stress during global financial crisis
  • High-quality assets could insulate investors, bottom-up analysis is key to staying liquid

Bond liquidity: let the music flow

Investors in today’s market face plenty of challenges, but a key concern for many is that liquidity in certain parts of the bond market can suddenly become scarce; it has happened before, and some investors believe it could easily happen again. The challenge for many is that predicting the timing of market stress is very difficult. Black swan events could also pose the risk of shock to the financial system. The global financial crisis of 2008 taught some big lessons to stakeholders including banks, other financial institutions, governments and central banks, leading to a significant tightening of regulations over the period that followed.

 

Still, the spread of Covid-19 caused some anxiety among market participants in early 2020. Central banks once again stepped into the ring, causing a sharp decline in bond yields, shrinking credit spreads and helping to smooth volatility. Governments also played their part to stimulate their economies. But speculation about when policy makers may withdraw support may induce swings in the markets.

 

Studying the macroeconomic trends closely can play a significant role in helping to maintain portfolio liquidity, even in times of market stress. Bottom-up analysis is also key, as the markets themselves can impact economic fundamentals and be key drivers of the broader asset classes. It’s also important to understand that a portfolio comprising low quality assets could face the brunt of any unexpected paralysis in markets. For instance, private debt markets can offer seemingly attractive yields, yet the market is often opaque and relatively illiquid. An investment philosophy grounded in pragmatism, and a highly active approach to risk management, combined with deep experience, could make a meaningful contribution to helping ensure your portfolio is liquid enough to face a wide range of eventualities.

Staying nimble and alert is the key to ensuring adequate portfolio liquidity. Absolute return funds tend to have high flexibility and make the most use of diversification, avoiding pure directional market plays to seek low correlation to markets. Jupiter’s Strategic Absolute Return Bond Fund continuously reinvents its portfolio to fit the macro environment. The fund predominantly holds sovereign bonds and avoids low-quality assets; liquidity is the key. If you believe that a traditional, long-only approach to fixed income investing risks becoming ineffective in today’s environment, the Jupiter Strategic Absolute Return Bond Fund offers a truly differentiated approach to achieving fixed income exposure, through its continuous reassessment of the economic and market environment and ability to express outright negative views on the direction of interest rates.

Strategic Absolute Return Bond: A dynamic and flexible approach

In today’s market, a long-only approach to fixed income investing is ineffective; there is room for a different approach to fixed income exposure. That’s why the team continually tweaks the portfolio to reflect the underlying macro environment.