The unusually calm market conditions of 2017 have given way to the swaggering return of volatility and generally rising US Treasury yields. But Ariel Bezalel, Head of Strategy, Fixed Income has believed for some time that the tide is set to turn and that the bull market in government bonds is far from over. Market conditions year to date have only strengthened his conviction. He explains why a prudent approach is now needed in an environment that is at a late stage of the business cycle and vulnerable to unforeseen shocks.

Executive summary

• We hold a more risk-averse stance in the Jupiter Strategic Bond Fund relative to the peer group and have adopted the most cautious approach in the history of the strategy.
• We aim to balance upside potential with the need to mitigate against downside risk. Our more defensive stance through increased government bond exposure has detracted from overall fund performance this year but has also aided resilience in turbulent market periods.
• We continued to build our defensive stance steadily during the year as our conviction in this positioning grew.
• High global debt levels, ageing demographics and disruptive technology are combining to form a lower growth, lower inflation investment backdrop. This is coupled with an unprecedented year for central bank activity with quantitative tightening set to accelerate alongside up to three US interest rate hikes.
• There are a number of apparently unrelated data points which indicate higher uncertainty and volatility in markets, all of which combine to form our view that a defensive stance is warranted.

A high conviction approach to portfolio positioning and duration

A conviction-led, total return mindset is critical to the way that we invest throughout different market cycles. 

Since mid-2017, we have built in a more risk-averse stance to the Jupiter Strategic Bond Fund relative to the peer group, the Investment Association Sterling Strategic Bond sector, and have adopted the most cautious approach in the history of the strategy. This has been expressed in lower beta high yield exposures (including a reduced allocation to higher risk Financials), partial hedges against the fund’s high yield and emerging market debt exposures, and higher allocations to high quality government bonds.

We deliberately opted to reduce risk to higher beta credit exposures while still in an environment of market strength and good liquidity and have been gradually building the fund’s duration as government bond yields have risen. While we are cognisant that these investment decisions reduced the return potential for the fund, we are always mindful of balancing upside potential with the need to mitigate against downside risk. 

My team and I take a high conviction approach to fixed income investing and the ability to adjust portfolio positioning in different environments is a key feature of the Jupiter Strategic Bond Fund. This is evidenced by our current defensive stance, which involved increasing duration from 1 to 5.5 years over a matter of 14 months in order to aim to mitigate against capital loss in an environment of growing uncertainty. (See Figure 1)

This dynamic, nimble approach to managing duration has long been our style and we have a historical propensity to take risk in environments where we are rewarded for doing so, with our high yield allocation reaching as high as 70% where we were able to identify attractive upside potential.

Figure 1: Strategic asset allocation and duration over time

This fund changed its investment objective on 19.12.13 to allow the manager to use derivatives for investment purposes.Source: Jupiter, 30.04.18. Fund launched on 02.06.08. *Includes interest rate futures. Asset allocation includes credit derivatives' exposure. **Cash does not include derivatives cash liabilities.

Figure 2: Jupiter Strategic Bond Fund performance since launch

Past performance is no guide to the future. This fund changed its investment objective on 19.12.13 to allow the manager to use derivatives for investment purposes. Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting, all performance is net of fees with net income reinvested. Source: FE/Morningstar, in GBP, from 02.06.08 to 30.04.18.
Ranked 3 / 40 in the IA Sterling Strategic Bond sector since launch. Fund launched on 02.06.08. IA = The Investment Association.

Heightened selectivity in special situations

In an environment of reduced risk premia and in line with our increased caution in credit, we have become deliberately more selective in our exposure to special situations.

That said, special situations remain an important alpha generator for us and recent additions such as Enquest, Boparan, Aabar demonstrate that we remain focused on taking security level risk where we believe we are well paid for doing so. The increased scale of our assets has not prohibited us from doing this successfully and at scale, albeit in what we view as a reduced opportunity set in today’s market. 

Performance year to date: defensive stance has helped and hindered

The low drawdown of the fund is an important characteristic of our strategy and this has been demonstrated in a variety of market environments. Taking a macro view on how much risk to take in changing market environments is a key feature of the fund, in contrast to more persistently ‘risk on’ products.

Turning to more recent returns, we adopted a more risk-averse approach from the middle of 2017. Our longer duration stance has been a key detractor from returns since Q4 2017 as US Treasury yields have moved steadily higher. It is important to note that it is our more defensive stance through increased government bond exposure that has detracted from fund performance this year – but, conversely, also aided portfolio resilience during recent political and market turbulence.

It has typically been the case that in more risk-averse environments, macro views have been a key driver of returns, while credit has contributed more positively in risk-on markets. While we have been somewhat early to build in a more defensive stance this year, historically the timing of our macro calls has proved effective at preserving capital and adding performance for our clients.

While selected positions in Emerging Markets (notably India) have recently been volatile, overall our credit exposure has held up well in an environment of heightened idiosyncratic risk. 

Macro outlook: cumulative causes for concern

We continue to believe that a cautious stance is the right way to be invested in today’s environment. It has long been our belief that high global debt levels, ageing demographics and disruptive technology are combining to form a lower growth, lower inflation investment backdrop. This is coupled with an unprecedented year for central bank activity with quantitative tightening set to accelerate as we move towards the second half of the year and the market looking at up to three interest rate hikes in the US. As we reach a turning point in the willingness of global central banks to provide liquidity to the markets, this is set to remove a strong historic support from both credit and equity markets.

Looking at economic fundamentals, we see a number of causes for concern: we are particularly focused on poor European data, concerns over the outlook for the consumer, the low level of money supply growth and the impact of higher oil prices. Turning to credit fundamentals, the high levels of leverage are a concern and we believe risks to the high yield market are asymmetric at this point. The number of apparently unrelated data points which indicate higher uncertainty and volatility in markets combine to form our view that a defensive stance is warranted – we would list Italy, Turkey, Argentina, the housing sector and sharp weakness in Bitcoin as well as areas of the ETF markets as cumulative causes for concern.

We have continued to build our defensive stance steadily during the year as our conviction in this positioning has grown. In a market that we believe is vulnerable to unforeseen shocks, caution remains our watchword.

Fixed income team update

As the assets under management of the Fixed Income strategy have increased over time, we have strengthened our team structure and underlying credit expertise. This has included the addition of four new credit analysts to the team over the last year: Reza Karim (Henderson, Emerging Market Debt, 6 years’ experience), Andrew Rubins (Eyck Capital Management, TMT/Healthcare, 6 years’ experience), Charlie Spelina (Bluebay, US credit, 10 years’ experience), and Leon Wei (Temasek, Oil/General Industrials, 8 years’ experience). The broader build-out of our emerging market debt capability by fund manager Alejandro Arevalo has also made a significant contribution to our strength in the EM area. A number of structural changes have helped us to manage business growth, notably the formal introduction of the Assistant Fund Manager, Head of Credit Research and Head of Fixed Income Dealing roles. We continue to invest in the fixed income team to ensure that we have the balance of macro and bottom-up skills required to add value for our clients over time.

Performance

Past performance is no guide to the future.

Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting; all performance is net of fees with net income reinvested. Source: FE, Jupiter Strategic Bond Fund I Acc, in GBP, to 30/04/2018.

Past performance is no guide to the future.

Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting; all performance is net of fees with net income reinvested. Source: FE, Jupiter Strategic Bond Fund I Acc, in GBP, to 30/04/2018.

Risks

The fund can invest a significant portion of the portfolio in high yield and non-rated bonds. These bonds may offer a higher income but carry a greater risk of default, particularly in volatile markets. Quarterly income payments will fluctuate. The fund uses derivatives, which may increase volatility; the fund’s performance is unlikely to track the performance of broader markets. Losses on short positions may be unlimited. Counterparty risk may cause losses to the fund. In difficult market conditions, it may be harder for the manager to sell assets at the quoted price, which could have a negative impact on performance. In extreme market conditions, the Fund’s ability to meet redemption requests on demand may be affected. The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. This fund can invest more than 35% of its value in securities issued or guaranteed by an EEA state

Important Information

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