Mike Riddell and Kacper Brzezniak on bond strategies in volatile times
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The year 2020 is proving to be one of the most unusual and volatile in financial market history. The coronavirus remains a threat and the recovery period may prove turbulent with further events prompted by pandemic costs and geopolitical friction.
IN THIS EDITION
For professional investors only. Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Allianz Strategic Bond Fund is a sub-fund of Allianz UK & European Investment Funds, an open-ended investment company with variable capital with limited liability organised under the laws of England and Wales. Past performance is not a reliable indicator of future results. Investment funds may not be available for sale in all jurisdictions or to certain categories of investors. For a free copy of the sales prospectus, incorporation documents, daily fund prices, key investor information, latest annual and semi-annual financial reports, contact the issuer at the address indicated below or www.allianzgi-regulatory.eu. Please read these documents, which are solely binding, carefully before investing. This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). Allianz Global Investors GmbH has established a branch in the United Kingdom, Allianz Global Investors GmbH, UK branch, 199 Bishopsgate, London, EC2M 3TY, www.allianzglobalinvestors.co.uk, which is subject to limited regulation by the Financial Conduct Authority (www.fca.org.uk). Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. This communication has not been prepared in accordance with legal requirements designed to ensure the impartiality of investment (strategy) recommendations and is not subject to any prohibition on dealing before publication of such recommendations.
Important Information
In this Focus, we talk to the managers of a fund designed to take a strategic view of global economics. Mike Riddell and Kacper Brzezniak, co-managers of the Allianz Strategic Bond Fund, tell us about their key goals and what makes the fund different from its peers.
They also explain how they develop coherent views in a world changing so fast that historical data and model predictions must form only one input to decision making. Here’s the question they continually ask themselves: Are markets pricing in a sufficiently broad range of outcomes?
No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment
© 2019 Incisive Business Media (IP) Limited
Justin Craib-Cox, CFA on the launch of the new RWC Sustainable Convertibles Fund and why this strategy aims to help weather market volatility
THE INTERVIEW
Can bond investors help change the world?
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We can take yield curve views, currency views, inflation views, across any market in the world
Time to get strategic on bonds?
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No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.
Campe Goodman, portfolio manager, Wellington Management
(1) The slight negative correlation is not always obvious to investors who consider the last 20 years as a whole, says Riddell, because fixed income and equity markets have both risen in that period. But it becomes apparent when correlation is viewed over 6- or 12-month periods or using rolling weekly correlations, he says. (2) In the 1970s, both bonds and equities did badly because of inflation, rising interest rates and recession.
time to build macro outlooks say Mike Riddell and Kacper Brzezniak, who co-manage the Allianz Strategic Bond Fund.
conomies around the world have been under attack from the coronavirus, governments have been exploring unconventional kinds of intervention, and volatile markets face an extended recovery period. That makes it a fascinating
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Their fund, launched in 2016, focuses on global economics and the two managers develop views not only on the relative value of government and other bonds but also on the yield curve, currencies, inflation and other macro drivers across the world’s markets.
In part, the fund was designed as a counterpoint to other strategic bond funds, which tend to invest heavily in corporate bonds. Credit-risky assets can behave rather like equities when the economic chips are down, says Riddell, reducing their portfolio diversification benefits for most investors.
“But remember what this is really about in the longer term,” says Brzezniak. “If you are holding a multi-asset portfolio with equities, like most investors, owning fixed income has the potential to allow you to own more equities, which over the very long run is likely to be a good thing.”
Changing correlations
The team are quick to point out that correlations between equities and government bonds are not fixed in stone. In the 1990s there was generally a slight positive correlation, says co-manager Mike Riddell, though still useful for diversification purposes. The slight negative correlation of recent years developed from the late 1990s – when central banks changed their inflation targeting.
What might cause that relationship to break down? “If a crisis turns out to be really bad,” Riddell says, “with massive central bank ‘helicopter drops’ of money to consumers, that could actually cause inflation and correlations could become more positive.”
For the moment, markets are more jittery about recession than inflation. But the observation points up how the team thinks. “Correlations can change,” says Brzezniak, and using models blindly can give you the wrong answer. “You’ve got to mix good historical analysis with an understanding of what was driving those correlations – and imagine new, different scenarios,” he says.
Relative risk
How does the team turn its fast-evolving macro views into strategy? “Two things are fundamental: what’s our macro view, but also what’s priced in,” says Riddell, who tracks a huge range of indicators from options markets to metals prices and money supply growth. “Particularly, is the market pricing in a sufficiently broad range of outcomes?”
“At the very beginning of 2020, we were actually quite bullish on the global economy but still weren’t overweight credit. Why? Not because we foresaw coronavirus. It was because credit was pricing in perfection in an imperfect world,” he says.
Brzezniak picks up the story: “If and when coronavirus dissipates, there’ll be something else – continuing recession fears, other geopolitical factors.” The aim of the team is to build a portfolio that incorporates some of those possibilities.
“We had a quarter of the fund in high yield corporate bonds at one point, in summer 2016,” says Riddell, making clear that the team can buy corporate bonds if it wants to. “But for some time up until March 2020 we had been outright short in vulnerable areas such as high-yield US corporate bonds.”
Going global
As this suggests, when the timing is right, the team can go more ‘risk-on’ in various global markets. “As another example, last year Italy was blowing up and seemed cheap on many metrics. We’ve had occasions where Chinese real estate seemed cheap,” says Brzezniak.
But the team say they don’t usually expect to remain ‘risk on’ for long or to position the portfolio so that it is highly correlated with equities, or they might fail in their longer-term correlation objective (see Fund Snapshot).
“Mostly over the last three years, we have been more defensive,” Brzezniak says, “because we were factoring in a rise in volatility.” That sea change has arrived and is revealing hidden rocks in many markets.
“We can take yield curve views, currency views, inflation views, across any market in the world,” says Riddell, and the liquidity of the fund means the team can move in and out of positions very fast. Over the next few years, they will be making the most of their unusually flexible mandate.
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The fact that many investors chased late-cycle credit assets into early 2020 represented the kind of asymmetric market skew that Riddell and Brzezniak like to hunt down. During 2019, being underweight corporate credit tended to lead to underperformance, “but not by a lot because the spreads were so tight,” Brzezniak says, whereas any future forced selling of illiquid bonds offered the potential for big market moves.
Diversity dry run
Two things are fundamental: what’s our macro view, but also what’s priced in?
2018 provided an early dry run for this diversification benefit. It was a risk-off year in which equity funds performed relatively poorly. But so did the many bond funds heavily allocated to credit.
“For our strategic bond fund, it was a good year – we outperformed. When everything else goes down, you may need a bond fund that isn’t just corporate credit,” says Brzezniak.
Source: RWC, Agilis Investment Management, 30 September 2019.
That’s not because the team try to predict market pricing. “People ask us, where do you think 10-year yields will be in a year; we say we don’t know. That’s the reality. We think about relative, not absolute, yields.”
In fact, Riddell says this March the team took advantage of the cheapest credit valuations in a decade to switch the portfolio around from being near 100% in very high-quality government bonds going into the corona crisis – plus various derivative overlays – to having half the fund in longer-dated investment grade corporate bonds.
Kacper Brzezniak, Portfolio Manager
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Justin Craib-Cox, CFA, portfolio manager
RWC Sustainable Convertibles Fund
Davide Basile, RWC, Head of Convertible Bonds Team
Mike Riddell, Portfolio Manager
Allianz
Allianz Strategic Bond Fund
Source: Allianz Global Investors, April 2020.
Three key objectives
Outperforming the benchmark
Source: Allianz Global Investors, Bloomberg, Allianz Strategic Bond Fund C Inc GBP (OCF = 0.65%), as of 30/04/2020.
Given this is a very flexible global unconstrained strategy, the fact that we aim to have no systematic biases versus the benchmark can help investors to envisage what the long-term return profile of the Fund may look like.
Achieving uncorrelated returns – we want to be on the bottom right!
The chart below summarises our track record achieving our equity correlation targets, versus the characteristics of many in the peer group. We have shown risk-adjusted returns on the x-axis, and correlation with global equities on the y-axis. Of those that have outperformed (righthand side of chart), many have done so through a high correlation to risky assets. We want to be in the lower right-hand side box, with no equity correlation to perform the role of a true portfolio diversifier, and a high information ratio.
Building an asymmetric portfolio
We take a value-based approach to global macro investing, seeking to find opportunities where the potential upside is greater than the potential downside. This is often achieved through finding contrarian investment opportunities, or through the use of instruments that can provide an asymmetric payoff. Indeed since launch the Fund has demonstrated a positive skew, as shown below.
FUND LAUNCH
21 June 2016
since inception
CORRELATION TO EQUITIES
£1,573m
FUND SIZE
IA £ Strategic Bond / Morningstar Global Flexible Bond
peer group
Rates, Credit, Inflation, Currency
CORE STRATEGIES
Key facts
NET INFORMATION RATIO
Source: Allianz Global Investors, as of 30/04/2020.
In order for the Fund to behave as we believe an actively-managed fixed income allocation should, we have three key objectives:
For guidance only and not indicative of future results.
Past performance is not a reliable indicator of future results. The Fund uses the specified benchmark as a comparator. This means that investors should use this index to compare the Fund’s performance.
Achieving all 3 objectives helps ensure your strategic bond fund acts as fixed income allocation should
Past performance is not a reliable indicator of future results.
Source: Bloomberg, 21/06/2016 to 30/04/2020.
Summary
The Allianz Strategic Bond Fund is designed to be different. We seek to outperform our global bond benchmark through any market environment, while explicitly targeting a zero correlation with equities.
Since launching the Fund, we have a successful and consistent performance track record, with zero correlation with equities. Through our risk management framework we have also achieved an
asymmetric return profile, with no significant drawdowns versus benchmark and much greater upside movements.
‘A bond fund that behaves like a bond fund’
Performance of the Allianz Strategic Bond Fund
Investment Association £ Strategic Bond Sector
0.03
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Mike Riddell and Kacper Brzezniak, Portfolio Managers
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How do the goals of the Allianz Strategic Bond Fund differ from other bond funds?
We don’t only have flexibility – we use it
Mike: The goal that really differentiates us is correlations. We launched this fund in 2016, knowing that many strategic bond funds are heavily invested in investment grade and high yield corporate bonds, and therefore behave like equities to a large extent.
We wanted to create something uncorrelated to equities – a diversifier, a true bond fund. We are seeking a zero correlation between our fund and global equities, call it MSCI World, over a rolling 3-year period (not over every day or every week), but up to a target maximum of plus 0.4 over a 3-year period.
Since we launched the fund, we are pretty much exactly zero. That’s over a 3-year period, but it’s only fair to stress that you can’t really control correlations, and there will also be times that we might want to be risk-on or risk-off.
Can you give an example of the risk-on/risk-off shift?
Mike: This Spring we moved to more ‘risk on’, from being near 100% in very high quality government bonds going into the crisis (plus overlays), to having half the fund in longer-dated investment grade corporate bonds, as risky asset valuations went to their cheapest in almost a decade.
That’s not to say the portfolio is now very highly correlated to equities – we never want all active positions pointing in the same direction and have a number of uncorrelated strategies and portfolio hedges in case the global economy fails to improve. Nor would we expect to remain ‘risk on’ for a prolonged period.
Mike: Aside from correlations, two other goals differentiate us: flexibility and asymmetry. We have a lot of flexibility away from our benchmark, the Bloomberg Barclays Global Aggregate (FX hedged), whether that’s being able to have half of the fund in high yield, if we think high yield is very attractive; use currencies that aren’t in our benchmark; take positions in inflation markets, both long and short, around the world, that are not in our benchmark; and take yield curve and duration views, again meaningfully away from our benchmark.
For example, benchmark duration is 7.2 years. In theory we can be between zero and 12 years, and in reality we’ve been between 3.5 and 11 in the last 18 months. So we don’t only have flexibility – we use it. The result is that we think we can generate alpha per year of around 200 basis points, though that is a goal and certainly not written in stone.
Kacper: Put simply, when we’re right we want to make more money than the amount of money we lose when we’re wrong. We think of it in two ways.
One way is finding ideas that seem asymmetric, sometimes for fundamental reasons. For example, in the UK, when we already had an interest rate cut priced into the UK fixed income markets, and the Bank of England doesn’t do negative rates and had specifically said they wouldn’t under Mark Carney.
You’re a small team with a lot of global flexibility – how do you cover the ground?
Kacper: We are in an almost perfect position because we have a small boutique-like team in London – four of us sit here – with access to, and input from, an emerging markets team in Asia, US and London; a global fixed income team; credit teams all around the world; and economic strategists all around the world.
How do you lever those resources into your investment process?
Kacper: There are three stages. The first bit is our macro outlook – looking at what’s priced in versus what we believe, or a disconnect between the data and the valuations. The second is generating ideas, whether they’re ideas that come from the macro analysis, standalone ideas, or hedges. And the last bit is the implementation where we put it all together, stress test, and so on.
Implementing our ideas requires great flexibility. Let’s say we think the world is going to blow up! Do we want to take advantage of that view in credit, rates, FX or a combination? In the US or Mexico? That’s where we actually spend a lot of our time: talking, testing, putting forward different ideas, running scenarios or stress tests of how they will perform. We can be quick to act – we’re not going to wait until next week and have a committee meeting.
Mike: Flexibility is critical because different markets – by geography, or emerging vs developed, or government bonds vs credit, or across the different investment tools – price in different things.
What else sets you apart?
What does your third goal – asymmetry – actually mean?
So the fundamentals seemed somewhat asymmetric, in the sense that yields could go up a lot more than they could go down.
The other way is asymmetric structures. For example, if you buy protection using a credit default swap, you pay a premium and your downside is limited to that, but your upside is potentially unlimited or very high. Again with an option, there’s unlimited upside, and downside limited to the premium. That’s a very important part of the fund.
This shows in our returns. We’ve had some quite big ‘up’ months/quarters, whereas the ‘down’ ones have been contained. That’s deliberate and it’s executed through those asymmetric trades, including hedges. For example, a stress test might reveal you are exposed to a fall in the oil price, and you can hedge that risk out. You don’t want to hedge away all risks but you do want to hedge certain factors.
We wanted to create something uncorrelated to equities – a diversifier, a true bond fund
Maybe currencies price in one outcome, while inflation markets price in a completely different one. That’s why we like a full global opportunity set and toolbox. Of course, you’ve got to get the view right!
Meet the Fixed Income Team, London
11 years’ experience: Joined AllianzGI in July 2016 Prior roles: Royal Bank of Scotland, London; National Bank of Fujairah; Dubai Bluecrest Capital Management, New York
Portfolio Manager
Kacper Brzezniak
4 years’ experience: Joined AllianzGI in July 2016 Prior role: Jupiter Asset Management, London
Associate Portfolio Manager
Jack Norris
17 years’ experience: Joined AllianzGI in October 2015 Prior roles: M&G, London; Premier Asset Management
Mike Riddell
To read regular fixed income updates and opinions from Mike, Kacper and the team, please visit our Bond Issues blog
* As of 1 May 2020, Daniel Schmidt, Product Specialist, has joined the team in London.
For further information on Allianz Strategic Bond Fund, please email investor.services@allianzgi.com or visit www.allianzgi.co.uk
