28.09.2022

An all-weather strategy for a tough macro environment

Global markets have faced a rough ride this year. How do investors navigate this choppy and uncertain environment? Ariel Bezalel and Harry Richards show how their strategy’s well-considered approach has historically delivered through some rough patches over the years.

When the going gets tough for the stock market, bonds are typically expected to act as a ballast in one’s portfolio. It’s very rare for both bonds and stocks to suffer heavy losses at the same time.

This year has been an exception. A confluence of factors has conspired to keep investors on tenterhooks: high inflation, faltering growth, rising interest rates, spiralling energy prices and a volatile geopolitical environment are some of the reasons for this peculiar and challenging market environment.

The Jupiter Strategic Bond Fund has a very good track record of riding out tough times because it takes decisions based on long-term macro views, combined with a deep analysis of issuer fundamentals. The investment managers of the fund typically look for their views to pan out over 12 to 18 months. The fund, launched in 2008, combines a top-down and bottom-up approach to fixed income investing. While the top-down perspective is formed on the back of intensive macro work, research by an extensive team of credit analysts underpins the bottom-up process.

The fund has navigated many important events and challenges over the past decade, including European Central Bank (ECB) President Mario Draghi’s famous “whatever it takes’’ speech to defend the euro, which was followed by the US Federal Reserve’s “QE Infinity’’.

Jupiter Strategic Bond performance through the years

Past performance is no indication of current or future performance, doesn’t take into account commissions and costs incurred on the issue/redemption of shares. Returns may increase or decrease as a result of currency fluctuations.

Source: Morningstar. NAV from inception on 02.06.08 to 19.09.11 is for the L GBP Acc share class. From 20.09.11 and until 31.07.22 is for the I GBP Acc share class.

Unexpected occurrences and turbulence have punctuated the period: the US Federal Reserve’s (Fed) “taper tantrum’’, the ECB’s expanded asset purchase programme, the Greek debt crisis, Brexit and the onset of Covid-19 were all part of the mix. Extremely accommodative policies meant as much as $18 trillion of negative yielding debt was sloshing around the global system as of December 2020.

While the performance has seen some short-term blip during various periods due to policy changes and market volatility, the longer-term philosophy of the fund has delivered top decile performance over the past decade.

The infographic above illustrates that the fund has managed to recover after each episode of drawdown. While the investment managers are cognisant of the twists and turns of the market over shorter horizons, their focus on forming a long-term view has proved fruitful time and again. Looking at the most recent period, the team has continued to show a contrarian and forward-looking approach. Since the beginning of the year, they’ve been highlighting the risk of a recession. This contrarian view has now become probably the base case for many market participants.

IMPORTANT PERIODS

MAY 2013 - BERNANKE TAPER TANTRUM

Navigating important events and challenges

Performance since inception to 31.07.2022. Past performance is no indication of current or future performance, doesn’t take into account commissions and costs incurred on the issue/redemption of shares. Returns may increase or decrease as a result of currency fluctuations.

Source: Morningstar. NAV from inception on 02.06.08 to 19.09.11 is for the L GBP Acc share class. From 20.09.11 and until 31.07.22 is for the I GBP Acc share class.

Macro view

Hard on the heels of Mario Draghi’s commitment to “do whatever it takes” to save the euro, the Fed unleashed “QE infinity” in September 2012, an open-ended quantitative easing (QE) programme which ultimately resulted in $85bn a month being injected into the US economy. A similar story emerged from Japan after Prime Minister Shinzo Abe swept to power on a pledge to take steps to kick start the economy. “Abenomics” was born and in April the Bank of Japan announced that it would roughly double the country’s monetary base over two years through a ¥120tn-¥140tn quantitative easing programme.

The frothy conditions created by the wave of stimulus by major central banks proved to be short lived, with Fed Chairman Ben Bernanke making a surprise announcement that the central bank may consider tapering QE as soon as September. Yields for US Treasury bonds rose sharply and posed a threat to the pace of economic recovery in the US. Emerging market debt and currencies sold off sharply.

Positioning

We adopted a “risk-on” in 2013 on the view that central banks and policy makers would backstop markets. This was expressed through a large weighting in high yield bonds. As the year progressed, we took steps to help protect the fund from a potential change in Fed policy. A lot of our interest rate exposure was hedged by shorting short-dated US Treasuries, for example, and by the end of the period we had about a third of the fund invested in floating rate notes. European corporate bonds presented some of the best opportunities for the fund during the period.

JUNE 2016 - BREXIT

Navigating important events and challenges

Performance since inception to 31.07.22. Past performance is no indication of current or future performance, doesn’t take into account commissions and costs incurred on the issue/redemption of shares. Returns may increase or decrease as a result of currency fluctuations.

Source: Morningstar. NAV from inception on 02.06.08 to 19.09.11 is for the L GBP Acc share class. From 20.09.11 and until 31.07.22 is for the I GBP Acc share class.

Macro view

Growth in the world economy remained lacklustre as the financial year began. Despite an unprecedented cycle of monetary easing by the world’s central banks since the financial crisis, inflation in many of the world’s major economies hovered close to zero. The first quarter of 2016 brought a sharp sell-off across financial markets on concerns over global growth and the plunging oil price. The shock Brexit vote in June roiled financial markets. The volatility proved short-lived, however, as the world’s central banks stepped in to steady markets after this latest shock.

Positioning

The positions in the fund which were designed to mitigate downside risk – such as US Treasuries, Australian government bonds and gold-related convertible bonds performed well at times of negative market sentiment, such as the sharp sell-offs at the start of 2016 and following the UK referendum result in June. This enabled the fund to perform competitively in a volatile period for risk assets. Our cautious approach when selecting corporate bonds also assisted performance.

MARCH 2020 FALL - COVID

Navigating important events and challenges

Source: Morningstar. NAV from inception on 02.06.08 to 19.09.11 is for the L GBP Acc share class. From 20.09.11 and until 31.07.22 is for the I GBP Acc share class.

Macro view

Global stocks and corporate bonds plummeted in early 2020 on concerns that the Covid-19 pandemic would plunge the global economy into a severe recession. The sell-off gathered pace throughout March as there was growing recognition that the outbreak was spreading beyond China. Global equity markets fell into bear territory (defined as a drop of at least 20% from a recent peak) while government bond yields fell to all-time lows. Central banks and governments reacted swiftly, announcing monetary easing and massive fiscal stimulus packages. Rallies in stocks and corporate bond markets followed in the second and third quarters of 2020 as sentiment lifted. Markets turned more sombre, and inflation hopes somewhat faded in September as the scale of economic damage caused by the pandemic became clear.

Positioning

Going into 2020, we were concerned that markets were vastly underestimating risks to the outlook, given the weakness of global economic activity combined with rich valuations in credit. The fund entered the exceptional crisis that began in March with defensive positioning: about 40% of the fund was invested in AAA-rated sovereign bonds, such as US Treasuries. Before the March crisis hit, the fund held 10% in shorts on US and European high yield markets expressed through credit default swaps. As the credit spreads ballooned in March, these hedges were unwound, contributing positively to the fund’s performance. The market’s weakness was used to buy high quality investment grade credit with resilient top and bottom lines. This included bonds from the likes of McDonalds and AB InBev and adding to our position in Tesco – nicknamed our ‘beer and burgers’ theme. Within high yield, we stuck to adding defensive senior secured debt and BB-rated bonds. Emerging market debt was cut as commodity prices fell, the dollar rallied, global growth slowed and tourism slumped. The defensive allocation, particularly in AAA-rated government bonds, stood us in good stead as other markets stumbled.

SEPTEMBER 2021 ONWARDS – STAGFLATION

Navigating important events and challenges

Source: Morningstar. NAV from inception on 02.06.08 to 19.09.11 is for the L GBP Acc share class. From 20.09.11 and until 31.07.22 is for the I GBP Acc share class.

Macro view

The fund faced some headwinds due to a toxic combination of high inflation and slowing growth. We had expected inflation to rollover quickly in 2022 but Russia’s invasion of Ukraine pushed up energy and commodities costs, clouding the picture. Yields rose as policy makers began to withdraw the extraordinary monetary and fiscal accommodation introduced to prop up the Covid-19 battered global economy. Global central banks also started to aggressively increase interest rates to cool inflation. But there are some encouraging signs for fixed income investors. Prices of commodities, including metals and agricultural products, have started to decline from mid-2022. A number of data points in the US and Europe show signs of slowing growth. We expect the Fed to review its hawkish bias later this year, which could trigger a rally in government bonds.

Positioning

As of end July the portfolio ran a duration (sensitivity to changes in interest rates) of around 8 years at the highest end of the historical range. The team sees heightened risk of recession that should halt, at a certain point, the capability of central banks to tighten materially more from here. As such current yields offered by government bonds in US, Australia, South Korea and New Zeeland look extremely compelling.

Over 50% of the portfolio comprises of high yield bonds. But we have tried to minimise risks by selecting short-dated papers and debt issued by companies in defensive sectors such as telecoms, healthcare, pharmaceuticals and hospital operators.

This barbell approach should help us to navigate any short-term turbulence in a recessionary environment, while still allowing to source compelling yields from the market.

The best of both top down and bottom up

Asset allocation decisions are made by analysing macroeconomic fundamentals, for which the team relies on a combination of external and internal research. Risk positioning is determined agnostically, and the team is not constrained by a house view or by a specific benchmark.

Credit selection is the result of high conviction fundamental analysis of issuers and issues across industries and geographies. The fund taps opportunities across investment grade, high yield and typically seeks to invest in the debt of companies with deleveraging potential, overtime growing earnings or paying down debt from free cash flow.

Duration

The ‘go anywhere’ strategy aims to achieve high income with prospect of capital growth and has a flexible duration approach. The fund’s approach to duration is both tactical and strategic. For instance, the fund’s duration was just two years in 2014 (which means a relatively low sensitivity to changes in interest rates) amid a backdrop of tightening Fed policy. At the end of July 2022, the duration reached 7.5 years, the highest level since inception.

Another example of tactical approach was the decision to cut duration to five years from six years in December 2021, as the flatness of the yield curve had reached extreme levels. The decision also partly reflected some of concerns that Chinese reflation and subsiding concerns around Covid would cause an uptick in yields. The approach was vindicated in December as curves steepened and yields rose.

Strategic asset allocation over time

The fund manager has the power to use derivatives for efficient portfolio management only, not for investment purposes. Source: Jupiter, as of 31.07.22. DM includes all Western European countries.
* Includes interest rate futures. Asset allocation includes credit derivatives exposure.

Protecting clients' capital

The strategy adopted by Strategic Bond since inception has translated into top decile performance against the peer group, but just as importantly outperformance during periods of economic stress . The portfolio management team has an important focus on the drawdown profile of the strategy and on performance at times of turmoil across risk assets and especially credit markets. Over its long history the strategy has tended to outperform when investors need it most, at times of economic turmoil, in particular economic shocks. A good example is the 2020 Covid crisis, where our drawdown was materially lower than competitors.

2022 has been a challenging year for the IA £ Strategic Bond category given the simultaneous sell-off in government bonds and credit spreads. Nevertheless, we think that this change in correlations should ultimately revert, re-establishing the diversifying power of high-quality bonds.

Transparent and simple

One of the additional benefits of this strategy is its simplicity and transparency. Capital is mostly invested physically in bonds issued by companies and governments across the world. Derivatives are used for hedging, and duration management. Material returns from FX are not core to the strategy, however, from time to time the managers may retain some modest currency exposure where they have extremely high conviction. Our returns over the past decade or more have come from picking the right bonds and making the right macro calls. The benefit for investors is that the fund is simple to understand, and because we aim to clearly communicate a long-term macro view and our current positioning, our performance should be in line with expectations. Avoiding defaults also helps mitigate the risk of losses.

A once in a generation opportunity

After one of the most difficult periods in living memory for fixed income investors as both yields and spreads lost money in 2022, the fund’s investment team sees significant value across fixed income with very attractive yields relative to underlying risk.

The fund’s thesis remains that the global economy is just at the start of a sharp slowdown, which will eventually put a lid on inflation and force central banks to relent on their tightening spree. That should lead to lower yields and recovery in fixed income assets. A similar situation existed just before the global financial crisis. In the middle of 2008, inflation was running at nearly 6%, yet by July of 2009 deflation had duly arrived. History repeats itself.

For now, we expect the Fed to be hawkish as inflation is still high and the labour market is tight. Political pressure ahead of the mid-term elections is another reason the Fed may stay the course. As we move through the rest of this year and into 2023, we expect the slowdown to accelerate, and inflation to roll over. We see this as a remarkable opportunity to invest in fixed income.

Given this backdrop, our preference is for the long end of the curve which is likely to continue to invert as the Fed’s tightening may pressure short end rates higher While we look for opportunities in the high-yield market, we are cautious as recession concerns may induce further volatility. Outside defensive areas of the market we prefer shorter duration instruments, idiosyncratic trades, or stories with clear positive catalysts for outperformance. At these wider spread levels, we are also seeing greater value in parts of the investment grade market, for example in real estate.

Fund performance

Cumulative performance (%)

	YTD	1 month	3 months	1 year	3 years	5 years	Since inception
Jupiter Strategic Bond Fund	-9.8	4.2	-2.2	-10.1	-1.8	5.4	144.9
IA Sterling Strategic Bond	-8.6	2.6	-2.4	-9.0	-0.3	5.6	81.0

12-month rolling performance (%)

	01 Aug ’17 31 Jul ’18	01 Aug ’18 to 31 Jul ’19	01 Aug ’19 to 31 Jul ’20	01 Aug ’20 to 31 Jul ’21	01 Aug ’21 to 31 Jul ’22
Jupiter Strategic Bond Fund	0.1	7.3	5.6	3.5	-10.1
IA Sterling Strategic Bond	0.3	5.6	3.9	5.5	-9.0

Past performance is no indication of current or future performance, and does not take into account commissions and costs incurred on the issue/redemption of shares. Returns may increase or decrease as a result of currency fluctuations.

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A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

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