Kevin Zhao, Head of Global Sovereign and Currency, Fixed Income
Kevin Zhao is the lead portfolio manager on all active Global Sovereign and Flexible Fixed Income Strategies as well as Active Currency Management. In this role he is responsible for all investment decisions taken for and implemented in these strategies. He is a member of the Fixed Income Investment Forum, and joined UBS Asset Management in 2011.
Have you made any significant changes to the UBS Global Dynamic Bond strategy given the outcome of the US election?
In the lead up to the November US election, we only made minor tactical adjustments while maintaining well diversified strategic positioning. We saw this as an event where we did not have an information advantage on how it would unfold politically. Therefore we preferred to wait for the election result before identifying key investment opportunities based on the expected economic policies from the new government and the new geopolitical landscape.
Of course, the UBS Global Dynamic Bond strategy is managed using a time tested, disciplined 4-step investment process of taking risks only when we see attractive reward opportunities with a thorough investment case.
Ultimately, this was a close presidential race and consensus expectations of a so-called “blue wave” failed to materialize. That said, in the aftermath of the elections, we found a compelling opportunity to add to our US rates position on market overreaction to the vaccine news.
Further, we increased our exposure to currencies that we believe should perform well in a risk on market environment such as the Australian dollar and emerging market (EM) currencies.
Specifically, the combination of a Biden win and positive COVID-19 vaccine news drove 10-year US Treasury yields close to the upper bound of what we deemed to be an attractive entry point. This was against the backdrop of the Fed expected to anchor short term rates for at least the next three years and a diminished chance of large fiscal stimulus.
Rates have rallied since we put on this position and we intend to trade this range tactically. Additionally, we added risk marginally across a variety of strategies as our outlook on the short term improved. For example we increased our allocation to corporates which we expect to benefit from continued spread tightening.
Further, we increased our exposure to currencies that we believe should perform well in a risk on market environment such as the Australian dollar and emerging market (EM) currencies. Finally we went from long to short positions in safe-haven currencies such as the Japanese yen.
Emerging markets are poised to be a beneficiary of a Biden administration. What does this mean for the UBS Global Dynamic Bond strategy’s exposure in these markets?
We generally agree that the outcome of the US elections should be supportive to risk assets, particularly EM, going into 2021. This of course is predicated on a number of important milestones including the ability of the new administration to be more integrationist, a successful rollout of COVID-19 vaccines and a more supportive global trading environment.
EM exposures within the UBS Global Dynamic Bond strategy are selective, comprised primarily of a diversified basket of hard currency bonds that provide a stable carry as well as a select number of local currency bonds from issuers with stable fundamentals and low inflation where central banks have room for policy easing.
We have held significant exposure to both local and hard currency EM bonds since the end of 2018. Back then we identified the peak of Fed funds rate, where the cutting cycle allowed EM central banks to be flexible with their monetary policy.
As always, our strategy will continue to emphasize the need to remain diversified across rates, credit and currency without unduly concentrating on one particular sector.
Going forward we do not anticipate any major changes to our EM positioning. However, we believe that we are well positioned to take advantage of any dislocations that may occur anywhere around the world should we experience sudden bouts of unexpected volatility over the coming months. As always, our strategy will continue to emphasize the need to remain diversified across rates, credit and currency without unduly concentrating on one particular sector.
Are there any major themes that will shape your strategy in Q1 2021?
The trend of persistently low yields on developed market bonds is one we expect to continue into 2021 with important implications for bond investors. In our recent publication of Panorama: Investing in 2021, we discussed structural drivers that will likely keep yields on developed market bond yields low for the foreseeable future.
While low levels of starting yields pose a challenge, they do not necessarily imply low total returns. One of the major benefits of our strategy is its ability to pull on multiple levers which aim to achieve attractive returns commensurate with our stated risk targets. As we enter 2021, we are focused on a balanced strategy that utilizes the flexibility we have in pursuit of our objectives. Our current strategy includes:
The trend of persistently low yields on developed market bonds is one we expect to continue into 2021 with important implications for bond investors.
- Relative value trades within developed market government bonds, where we believe that certain markets have room to perform on a relative basis. One example is to stay long the US and New Zealand versus the UK.
- Sensible allocation to diversified credit, where quality carry should remain supported by central banks' accommodative policies and could outperform on an excess return basis.
- Allocation to emerging markets bonds where we have a favorable outlook. Our focus is on those central banks that have ample policy tools to support their economies. On the other hand we think Central and Eastern European central banks will face renewed inflation pressure and are likely to respond by tightening policies in 2022 or 2023. These economies which were already overheated prior to the COVID-19 shock benefitted from further aggressive easing during the lockdown. Consequently we see growth rebounding strongly in the coming years. In these markets we prefer short duration positions, where we think that yields are likely to rise.
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