Meet the fund manager: Picking the best bonds in the world
In this weekly series, investment reporter Elliot Gulliver-Needham sits down with a fund manager for a Q&A. This week, we’re hearing from Matthew Rees, head of global bond strategies at Legal & General Investment Management.
How does your fund stand out from others in the same market?
We have a truly global approach. We will invest, using our in-house experts, in emerging market or high yield debt when we believe that the risk-reward profile of the asset class is appealing.
We explicitly embrace a team-based approach. We believe that the days of “star fund managers” are long gone; the complexity of fixed income markets are such that well- resourced and experienced teams are best placed to capture opportunities whilst mitigating downside risks.
Which of your holdings are you most excited about?
Our primary generator of returns is to focus on the diversification of asset classes, as well as individual bond holdings, seeking un-correlated returns to produce best in class performance.
But within those individual holdings, we are truly excited about the recovery in the European property sector and holdings in corporate senior and hybrid securities issued by selected German and Central European property REITs (real estate investment trusts).
Our investors have already benefited as yields and bond prices have somewhat recovered from levels that wouldn’t have been out of place in the Global Financial Crisis. However, we still see strong returns over the year ahead.
The REITs we have selected are steadily deleveraging through patient asset sales while they continue to generate good rents from their existing diversified property portfolios.
We are also somewhat more positive on European growth and the slow reduction in European interest rates will also act as a tailwind as they refinance their debt structure over time.
What is the biggest mistake you’ve ever made in the fund?
Having been a bank analyst many moons ago, I would have hoped I would have dodged the worst of the latest financial failures that erupted last year in March 2023, as we have successfully done since the Global Financial Crisis.
Although we didn’t have any of the US regional banks that went bust, we did have exposure to Credit Suisse AT1 (deeply subordinated) bonds. We believed that Credit Suisse’s 2022 restructuring plan and capital raising would be just about enough to get them out of the precarious situation they had placed themselves in.
However, we misjudged the rapidity of bank deposit runs in the age of social media, as well as the regulator’s willingness to generate capital by writing down AT1 bonds that would help UBS to rescue Credit Suisse.
We believed that the write-down of Credit Suisse’ AT1 bonds would force many investors to re-evaluate their exposure to AT1 bonds more broadly, so we proceeded with the sale of some of our exposures to those bonds at depressed prices.
The experience was a salutary reminder to me of the importance of diversification of exposures, particularly in more cyclical or subordinated positions, as well as how incorrect is the old adage that you cant teach an old dog new tricks.
We always endeavour to learn from our mistakes, as well as not be scarred by them. We could see from market behaviour that investors hadn’t deserted the bank AT1 asset class and so increased our exposure again during the year, generating strong returns that more than offset the losses from the CS incident.
What’s one change you made in the fund recently? Why didn’t you make it sooner?
We increased our allocation to Emerging Market debt and Global High yield in February, from 32 per cent to 43 per cent, and reduced our exposure to investment grade corporates to “pay” for it.
Investment grade spreads, particularly in the US, had rallied hard into February to levels that we found (and still find) quite expensive.
As a result, the relative yield attractiveness, particularly in Emerging Market high yield issuers, was appealing. We didn’t make the decision sooner as we needed to see more evidence of the improvement of the macro- economic backdrop in the US, as those asset classes tend to be more sensitive to market moves.
In addition, we were becoming increasingly comfortable in our belief that the demand for credit assets, notably in higher yielding areas, would persist. Additionally, both EM and high yield have lower duration so are less sensitive to moves in government bond yield markets. We therefore happily balanced the overall risk profile of the fund by an increase in its credit sensitivity while reducing the interest rate sensitivity.