An update on our global sovereign bond strategy - Global bonds and currencies
Newton Fixed Income
November 2011
Paul Brain
No. 318
Newton's fixed income investment solutions
This table outlines Newton's fixed income solutions. Newton may offer other strategies that seek to
meet these client requirements.
Given the significant divergence in government bond market fortunes over recent weeks and months1, we thought it would be worthwhile to explain the current exposure of our key bond strategies.
Our global sovereign strategy has an interest rate sensitivity, as measured by its modified duration2 ('duration') of 5.95, compared with the duration of the JP Morgan Global Government Bond Index of 6.79 years3. A bond portfolio with a lower duration than another would be expected to exhibit lower sensitivity to changes in interest rates, as well as less volatility.
We believe the deleveraging process will continue for some time and that different countries will, through necessity, follow different paths. In anticipating these paths, we have categorized economies into three groups:
- The 'printing money' group
- The 'rate-cutting' group
- The eurozone group
The printing money group
Many countries are in the midst of fiscal austerity4 and we believe the burden of maintaining economic momentum in these countries, therefore, is with the central banks. Some, we observe, are already at or close to the limit of conventional loose monetary policy and have had to resort to additional measures such as quantitative easing. The willingness of central banks to maintain growth is, perversely we believe, supporting those bond markets because it reduces the risk of default. This 'printing money' group has attracted,5 and should continue to attract we believe, safe-haven capital flows that will keep their bond yields low.
Exhibit 1 shows our global sovereign bond strategy's duration exposure to this printing money category. Total duration exposure to this group is 3.3 years, compared with an index weight of 5.0 years. Although Japan is in this category, we believe the ultra-low bond yields available in Japan do not offer much in the way of capital appreciation and the country's gradually deteriorating credit quality suggests significant downside risk when Japan runs out of domestic buyers.
Exhibit 1
The rate-cutting group
Some countries were able to raise interest rates over the last couple of years as headline inflation and growth rose6. We believe such countries can counteract the global slowdown by cutting rates from here. The global sovereign bond strategy's total duration exposure to this group is 1.6 years, compared with the JP Morgan Global Government Bond Index duration exposure to the group of 0.2 years7.
Exhibit 2
The eurozone
Exhibit 3 shows the strategy's euro-denominated country exposure. Eurozone countries do not have control of monetary policy and, although the European Central Bank ('ECB') is highly likely, we believe, to cut interest rates again soon, it is our conviction that the growing crisis is becoming too great to allow that to be the limit of the ECB's intervention.
Eventually, we believe the ECB will join the 'printing money' camp, but only as a result of a full-blown banking crisis. We are monitoring signs of stress in the financial system. These have been rising since the beginning of the summer8, but as yet we believe the bureaucrats and the politicians haven't noticed. We see the danger as being that they leave it too late and that even an ECB injection of liquidity into the banking system will not be sufficient to maintain growth.
We have avoided the 'middle group' of countries (France, Belgium and Austria) all year as, until recently, the yield spreads on their government bonds (over German equivalents for example) didn't, we believe, compensate the investor for the risks associated with holding those bonds. Our peripheral bond exposure has also been very light; we sold the strategy's small Italian bond position in October. Exposure to the core countries (Germany, Finland and the Netherlands) has been reduced this month as the chances of contagion spreading to the core (through burden sharing or capital flight) have increased. Overall duration exposure to this group is 1.01 years, versus JP Morgan Global Government Bond Index duration of 1.44 years.
Exhibit 3
Currency strategy
We have taken euro exposure to a greater underweight than previously, and we have also sold some riskier currency positions (the Polish zloty and Malaysian ringgit) back into the U.S. dollar. The combination of the greater risks of a Chinese slowdown and a 'softer' U.S. economy, as well as the crisis in the eurozone, are taking their toll, we believe, on the global economic outlook. The U.S. dollar tends, we observe, to be a beneficiary when global growth falters and when stresses rise in the financial system.
Global Dynamic Bond strategy
The strategy's allocation has shifted towards safe-haven markets. High-yield exposure has been reduced, from 18% to 16% in recent weeks, and we have raised exposure to government bonds over the same period from 25% to 31%. The government bond component has been increased in line with the rationale above. There are no eurozone government bond holdings in the strategy, but we are emphasizing exposure to the 'rate-cutting' and 'printing money' categories in line with the global sovereign funds.
1Source: Bloomberg, 11.25.11
2Modified duration is the change in the value of a bond or portfolio/index of bonds that will result from a given change in interest rates. It is stated in years but, unlike maturity, duration takes into account the coupons (interest payments) that occur throughout the course of holding the bond or portfolio/index of bonds.
3Source: Bloomberg; Newton, November 25, 2011
4Source: Financial Times, 10.20.11
5Source: Bloomberg, 11.25.11
6Source: Bloomberg, 11.25.11
7Source: Bloomberg; Newton, 11.25.11
8Source: Wall Street Journal, 11.17.11
This is a financial promotion and is not intended as investment advice. This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorised. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. No warranty is given as to the accuracy or completeness of this information and no liability is accepted for errors or omissions in such information.
'Newton' refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Capital Management Limited, Newton Capital
Management LLC, Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited. NCM LLC personnel are supervised persons of NCM Ltd and NCM LLC does not provide investment advice, all of which is conducted by NCM Ltd. Except for Newton Capital Management LLC and Newton
Capital Management Limited, none of the other Newton companies offer services in the U.S. The opinions expressed in this presentation are those of Newton and should not be construed as investment advice. Past performance is not a guide to future performance. The value of your investment may go down as well as up.
In the U.S. this document is issued by Newton Capital Management Limited, the Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Capital Management Limited is an investment management firm authorized and regulated in the United Kingdom by the Financial Services Authority and is wholly owned subsidiary of the Bank of New York Mellon Corporation. Registered in England no: 2675952. Newton Capital Management Limited is registered in the United States as an investment adviser under the Investment Advisers Act of 1940. Newton Capital Management LLC provides marketing services in the U.S. for Newton Capital management Limited. Tel: (212) 922 7331 www.newtoncapitalmanagement.com
In Jersey, this document is issued by Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited both of Liberté House, 19-23 La Motte Street, St Helier, Jersey, C.I. JE2 4SY. Both companies are regulated by the Jersey Financial Services Commission. 19795 10/11.
BNY Mellon Asset Management is one of the world's leading asset management organizations, encompassing BNY Mellon's affiliated investment management firms and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation.
