Navigating through uncertain economic times

Kevin Zhao explains how flexible the UBS flexible bond strategies really are using market examples of where flexibility was essential in managing the portfolio effectively.

15 out 2020
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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.

1. The UBS Global Dynamic Bond strategy has a very flexible investment approach. Can you name a market situation recently where you availed yourself of such flexibility?

One of the major advantages of flexible guidelines is they allow portfolio managers to deviate from standard bond benchmarks, providing them the opportunity to take advantage of diversified investment opportunities around the world and across all fixed income asset classes, such as emerging markets, high yield or inflation linked bonds. At the end of 2019, we had concerns over high inflation in India despite consensus expectations of rate cuts by the Reserve Bank of India (RBI). We took a stance that the high inflation environment in India meant that there was a low probability of rate cuts by the RBI despite consensus expectations to the contrary. To express our views, we went short duration in India and subsequently exited the position after the market priced out any chance of an RBI rate cut.

In the immediate aftermath of the economic challenges brought on by the COVID-19 pandemic, we took advantage of the strategy’s flexibility to shift our duration position to long in anticipation of monetary easing by the RBI. As we anticipated, the central bank acted swiftly and decisively, slashing interest rates and injecting sizable amounts of liquidity into the market. 

Similarly, flexibility is useful for managing risk in instances where our thesis on an investment fails to materialize. As an example, prior to the pandemic, we had long exposure to commodity and pro-growth currencies including the Australian dollar and the Norwegian kroner, which sold off substantially in the ensuing volatility and flight to quality. As a result of our flexible approach, we quickly and considerably cut our positions to limit the drawdown and reduce overall portfolio risk.

India 5-year swap (%)

Chart shows India 5-year swap rate over the past year

Similarly, we purchased 6-year US Treasury inflation-linked bonds (TIPS) as real yield actually increased after the COVID-19 outbreak. The Fed slashed the rate to near zero and markets panicked by pricing in substantial risks of deflation in the US, even though all factors were pointing to a determined resolution by authorities to engineer the largest fiscal and monetary stimulus in history.

2. In addition to the UBS Global Dynamic Bond strategy, you also manage the UBS Global Flexible Bond Strategy. Can you explain the differences between the two strategies?

We manage a variety of flexible bond strategies ranging from benchmark agnostic to high alpha, flexible, but benchmark-relative fixed income strategies. The main difference between them is absolute versus relative return to the investable market. Our flagship total return bond strategy – Global Dynamic – does not have a benchmark, but that is not to say it is unconstrained. The strategy is governed by investment guidelines with limits to duration, rating and risks for a balanced asset and country allocation and well diversified investment strategy. Specifically, the strategy pursues investment flexibility across markets and fixed income sectors and provides diversification with ample liquidity and a credit quality profile that is investment grade on average. Overall portfolio duration range is set at 0-10 years, with the ability to go short individual markets by using futures or swaps. In addition, the overall portfolio volatility is managed within a range that represents the long term bond market volatility of approximately 4-6%. As a result, the strategy seeks to be a diversified best ideas portfolio with absolutely no biases: if we own something, it is because we like it and believe it represents an attractive risk/reward opportunity.

The UBS Global Flexible Bond strategy has a different starting point or anchor, which is the Bloomberg Barclays Global Aggregate Bond Index. The strategy is designed to achieve an attractive alpha target versus this benchmark using independent and non-correlated sources of return, while also exploiting a full fixed income opportunity set both within and off benchmark. Within the off benchmark universe the strategy can invest in sectors such as EM debt, high yield corporates and currencies with pre-defined guideline limits, much like the UBS Global Dynamic Bond strategy. The main difference is that the investment guidelines for the UBS Global Flexible Bond strategy are set with reference to its benchmark, whereas the UBS Global Dynamic Bond strategy is managed with guidelines that are absolute. In essence, the UBS Global Flexible Bond strategy is for investors who seek attractive returns through a flexible bond strategy, but require a benchmark for relative risk management purposes.

In addition to the UBS Global Flexible Bond strategy, we have other thematic strategies for specific investor needs which run on the same principle. 

Read more on our flexible fixed income capabilities here

3. In the past month have you made any changes to the UBS Global Dynamic Bond Strategy?

We recently exited our exposure to US TIPS. For now, we believe breakeven inflation expectations in the US have recovered to near fair value after a sharp sell-off in March. In addition to that, we have also reduced our long duration positions in the US and Mexico. This adds further ammunition in a scenario of rising bond yields as these economies recover and the respective policymakers introduce further fiscal stimulus.

Looking ahead, while the initial impact of COVID-19 has been clearly disinflationary, the combination of aggressive fiscal expansion and enormous monetary stimulus could potentially shift long run inflation expectations higher in the coming years especially if we will witness major supply disruption from deglobalization and economic nationalism. Should this scenario play out, we believe that our strategy should benefit from its focus on taking positions in markets where central banks have the appropriate policies in place to achieve their inflation targets.

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