Is it time for an unconstrained strategy?

Added 13th May 2015

Is it time for an unconstrained strategy?

“There has been a big increase in demand for unconstrained investing strategies. A lot of investors are concerned about the sell-off in emerging markets in case the US Federal Reserve hikes rates,” Stitt said, in an interview with Fund Selector Asia.

“They are still drawing parallels from the taper tantrum. A lot of clients are, therefore, interested in asset allocation capability coupled with active duration management and currency management.”

Unconstrained investment strategies have greater flexibility to alter asset allocation across various fixed income sectors, she said. 

Furthermore, active duration management could help these products reduce interest rate risks that typically arise in traditional bond funds.

Stitt shared the asset allocations strategies adopted in some of Legg Mason’s global unconstrained bond funds.

Long US treasuries, high yield preferred

US rate normalisation is going to be a slow process, and it will impact short duration bonds more than long-term bonds, she said. 

“Everyone is expecting the yields on the short-term bonds to go up. But the real interesting thing is the market is not expecting much movement at the long end of the yield curve [30-year bonds].

“The best way to make money this year is to be at the long end of the curve and be quite tactical on the overreactions at the short-end.

“There is going to be a technical demand for the US dollar and US treasuries. The yield on the 10-year US bond looks far more attractive than European or Japanese bonds.”

Given that the US economy is improving, the firm likes high yield bonds too, Stitt said.

“In some of the portfolios, we started increasing allocation to high yield energy bonds in December and then also during the sell-off in March. We are now overweight high yield energy bonds.” 

India favoured in EMs

Legg Mason likes the Indian fixed income market for its attractive yields on sovereign bonds and currency.

“It has a good yield [about 7.75%], great dynamics, inflation is coming down, the reform story is great and plus it [the market] is not correlated to US treasuries. It is a very domestic-focused economy.” 

The firm has invested in emerging markets such as Brazil and Mexico for specific reasons, she said. 

Mexico is undertaking structural reforms and she believes there are investment opportunities in long bonds.

Brazil, Stitt said, is beset with difficulties, yet pays an attractive yield.

“From a fundamental perspective, at the moment Brazil is in a tough position. There is recession, high inflation, political uncertainty, social unrest and corruption.

“But if you buy a three-year sovereign bond denominated in Brazilian real, you get a yield of roughly 13%. You can hold the bond until maturity with that 13%. It is a yield opportunity.” 

European mortgage securities

The fund house prefers European mortgage securities, as yields on core bonds are at “exceptionally” low levels following the European Central Bank’s massive stimulus programme.

“We think the mortgage market is the best way to play the European recovery and it is a cheap asset class. The housing market is a lot healthier now. The ECB is also buying these securities as part of its purchase programme.”

The fund house also likes European high yield in some of its products.  

“Even with tighter spreads and lower yields relative to the US high yield market, the improving economic conditions will make these securities more fundamentally attractive."

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