From absolute return products to multi-cap equity portfolios, funds with a flexible remit should be better equipped to withstand changing market conditions. But their success rate usually depends on what exactly a fund manager is trying to do – and whether they have made the right calls.
The difference in possible outcomes can be seen among flexible bond funds, which have all the tools to navigate shifts in fixed income markets, but tend to do radically different things. From 21 February to 23 March, in a sell-off where government bonds stood out as one of the few reliable safe havens, just five of 95 funds in the Investment Association’s Sterling Strategic Bond sector made a positive return. This in part reflects the fact that some flexible bond funds look to generate yield by buying riskier debt, rather than investing more defensively.
The name that fared best in this period, and has continued to do extremely well this year, is Allianz Strategic Bond (GB0031383408). Run by Mike Riddell and Kacper Brzezniak, the fund aims to outperform its benchmark, to have a three-year correlation of 0 to the MSCI World equity index, and to offer "asymmetric" returns by effectively having bigger wins than losses. As Mr Riddell puts it: “The main reason to own our fund is actually diversification if you own lots of equities and want to protect yourself if things go wrong.”
At the start of 2020 the managers looked to prepare for a strengthening global economy by buying inflation-linked US Treasuries (commonly called Tips) and maintaining a low level of duration, or sensitivity to interest rate changes. But from late January the team suspected that Covid-19 would trigger volatility, at a time when markets were pricing in "either little risk or no risk of an imminent recession”.
As such they moved to a more defensive positioning. Rather than buying long-duration government bonds, which benefit in times of economic weakness, the team focused on corporate bonds and currencies, which they viewed to be the most mispriced. The team took short positions on corporate bonds, betting on their values falling, while also using currency hedges to position defensively. The success of this strategy meant that the fund made similar gains to those of long-dated US government bonds.
Having benefited from a defensive approach in the sell-off, the team changed tack in late March. “We didn’t want to be defensive any more. We thought things were cheap and we wanted to own them,” says Mr Riddell.
This involved buying investment grade bonds which, in the wake of such extreme volatility, were trading at prices usually seen on “distressed” debt – something the team viewed as attractive given the low probability that companies with higher credit ratings would collapse or default on their debt. The managers bought the debt of Walt Disney, Oracle, Toyota, Exxonmobil, BMW, Volkswagen, Daimler and General Motors.
Corporate bonds made up around half of the fund’s assets at the end of June, but a combination of significant price gains and a wish to "de-risk" have prompted the team to sell its positions in many of these names over recent months. Those with higher credit ratings, such as Oracle, Toyota and Exxonmobil, have entirely exited the fund. More cyclical investment grade names with lower credit ratings such as General Motors have remained for the time being. Mr Riddell has generally steered clear of riskier high-yield bonds – both because of the chance that such companies could default on their debt, and because high-yield bonds tend to be correlated with equities.
Speaking in early August, Mr Riddell explained: “Six weeks back the macro risks were increasing: we thought there might be a second wave, but a lot of what you’ve seen might still be the first wave, and the second wave might hit in the winter. So it makes more sense to be defensive.
“We sold lot of the corporate bonds we had bought and increased our hedges on currencies. Commodity currencies such as the Australian dollar had done too well so we went short.”
The team also has short positions on sterling, with the rationale that the currency suffers when equities fall. By contrast the team is long the Japanese yen, which tends to rally at times of volatility.
Government bonds and government-related debt made up around half of the fund at the end of June, but the team’s approach here is relatively nuanced. This includes a “neutral” stance on duration and a mixture of exposure to different global government bonds: Mr Riddell worries that UK government bonds look expensive, but believes higher yields (and lower prices) can be found on US Treasuries and Australian government bonds.
The team is also keeping an eye on the prospect of inflation returning, which tends to be extremely harmful for bonds. Mr Riddell has recently maintained a focus on inflation-linked bonds in the US and Europe, which look cheap. By contrast, he views UK inflation-linked bonds as overpriced.
Mike Riddell CV
Mr Riddell joined Allianz Global Investors in October 2015. He previously spent 12 years working on bond portfolios at M&G, having also worked at Premier Asset Management. He graduated from Birmingham University in 2001 with a BSc (Hons) in money, banking and finance, and is a CFA charterholder.
Mr Riddell has broad experience of fixed income markets, having previously run funds focusing on the likes of emerging market bonds, index-linked bonds and global government bonds.
