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Why this bond manager is increasing exposure to his worst performing bets

09 December 2022

Emerging markets were the biggest detractor to Morgan Stanley Global Fixed Income Opportunities’ performance this year, but its manager is increasing allocations there for 2023.

By Tom Aylott,

Reporter, Trustnet

The Morgan Stanley Global Fixed Income Opportunities fund has generated top-quartile returns over the past one, three, five and 10 years and has even made a positive return in 2022 (up 2.8%).

Yet despite years of consistent outperformance, it has been a struggle to offset downward traveling bonds this year, according to manager Michael Kushma.

Emerging markets were one of the biggest detractors to performance but Kushma said that he is increasing exposure to them heading into 2023.

Here, the manager of the $3.3bn (£2.7bn) fund also tells Trustnet how he’s increasing risk in his portfolio next year and why he thinks the dollar has passed its peak.

 

Total return of fund vs sector in 2022 and over the past decade

Source: FE Analytics

 

What is your investment approach?

Our strategy lets us go anywhere and do anything within reason. In other words, it's not meant to be a super aggressive fund, but it's meant to have a wide opportunity set.

It's meant to have below investment grade exposure, but also an average investment grade rating so that it meets that minimum criteria for investors.

 

What sets you apart from your peers?

I would say it's our focus on diversification and exposure to a wide swathe of fixed income securities, not just across sectors, but across countries around the whole globe.

I think there were very few strategies out there that have the skill set to find opportunities everywhere.

 

How have you been shifting allocations over recent months?

Over the course of the year, we’ve been trying to keep risk low because we were more optimistic at the beginning of the 2022 that things wouldn’t turn out as badly as they did – we've been surprised at how high inflation had gotten.

We've been doing a lot in the past couple of months, particularly since the problem in the UK financial system in September, which caused a pretty big sell-off in duration and credit spreads.

Since, we’ve been adding risk to the portfolio, primarily by reducing our very underweight exposure to Europe and the US, where central banks have been tightening a lot.

We’ve also been adding exposure to investment grade credit, to high yield, and even to emerging markets which had gotten to very low levels of over the course of the year.

We've moved to an underweight position in the US dollar for the first time in a long time – it’s not a large change, but a meaningful position now that we think the dollar has peaked.

 

What makes you think the dollar has peaked?

It is a combination of US monetary policy getting to the end of its tightening cycle as well as valuations. We were getting good news for the dollar, rate hikes in the US and strong inflation numbers, which suggested more Fed tightening and bad news on the euro side.

Our view now is that the momentum had come to an end, otherwise the market would become sufficiently overweight dollar and underweight euro. There has to be a turn in US fundamentals that would lead to the better performance of other currencies versus the dollar.

 

How did you react to that volatility in the UK in September?

The single biggest change we made to a portfolio was going from no interest rate risk in the UK to a meaningful risk.

Turbulence in the UK government bond market suggested that risk was rising, but it seemed unlikely to us that the Bank of England would tighten that much considering the already weakened state of the economy.

We purchased index-linked gilts for the first time and took advantage of turbulence to add exposure to the UK, which we maintain through to today.

 

What were your best performers this year?

Everything we owned for the entire year has generated a negative return, so the question is, ‘how big a negative return?’

The things we’ve added from September have added return to the portfolio, but not enough to offset all the losses.

We reduced our bond duration from six years down to just two, which is historically as low as we get. It still didn't help us enough as it generated almost 4% of losses for the year as a whole.

Two years of total duration is as low as we've ever been willing to go otherwise we think the fund is turning into something it's not – it’s a bond fund, not a money market fund.

 

What were your worst performers?

I would say emerging market high yield debt did particularly badly, even in the big commodity exporters in Africa and Asia.

It had a very bad year, and we had some exposure to that at the beginning of the year, which we have since cut. Those bonds generated somewhere between a 10-20% loss for us.

 

What are you most excited about?

Coming up to 2023, one area where we think we could add a lot more exposure as things settle down is in emerging markets.

They’ve been hammered by monetary tightening and high inflation, but central banks in Latin America in particular have shown no willingness to relent on tight policy, even though they raise rates much earlier than the US.

We're really looking for a sign that central banks in emerging markets are ready to begin cutting interest rates, but we're not quite there yet.

 

What are you interests outside of fund management?

I’m an avid tennis player – I taught my children and I’ve now started teaching my granddaughter how to play.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.