Robeco Lux-o-rente does it again: sell-off avoided

Robeco Lux-o-rente does it again: sell-off avoided

22-06-2015 | Insight

In the recent-sell-off on global government bond markets, Robeco Lux-o-rente managed to maintain a positive year-to-date return with its active duration positioning. This illustrates the importance of an active investment approach.

  • Olaf  Penninga
    Senior portfolio manager fixed income

Speed read

  • Quant duration strategy anticipated recent yield rise
  • After benefiting strongly from last year’s bond rally
  • Strong long-term track record confirmed

After a good start to the year, global bond markets have given up all their year-to-date gains in the recent sell-off. This illustrates the importance of an active investment approach, aiming to capture the gains and avoid the losses. Robeco Lux-o-rente offers such an outspoken investment approach. While the fund benefited strongly from the bond rally in the second half of 2014 and early 2015, it is currently positioned very defensively to protect against the rise in yields. With this active positioning, the fund has managed to maintain a positive total return year-to-date, while global bond indices fell into red numbers in June.

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“Get used to volatility”

Bonds got off to a good start in 2015, continuing their strong run from the second half of 2014. Declining oil prices dragged already-low inflation to even lower levels. Expectations for the Fed to start hiking rates receded and the ECB announced its Quantitative Easing program to push inflation back to its target. 

Oil prices stopped falling in February-March and rose in April. As a result inflation expectations moved up again. Growth in the EMU countries was boosted by cheap energy. These positive developments hurt the bond market. Many investors had bought long-dated bonds as they expected the ECB’s QE program to drive yields even lower, or simply because the yields on shorter-dated bonds were so low. Bonds have sold off sharply since late April as many investors have been trying to reduce their positions at the same time. German 10-year yields rose from 0.07% in April to an intraday high of almost 1% in early June. US Treasuries also fell as economic data recovered from the weakness in the first quarter and Yellen indicated the Fed aims to hike rates later this year. The ECB is obviously not in a position to consider rate hikes, but Draghi also contributed to the sell-off. Market pundits had expected him to calm down bond markets at the 3 June press conference, but Draghi told bond market participants bluntly to “get used” to higher volatility. This contributed to the biggest two-day sell-off in Bunds since 1998.

Forget about yield levels

The recent moves in bond markets nicely illustrate how bond returns are much more driven by changes in yields - and the resulting capital gains or losses - than by the level of yields. The German 30-year bond yielded 1.3% at the start of 2015. However, investors did not need to wait a full year to earn 1.3%; rather, this bond returned more than 10% already in January as strongly falling yields boosted this bond’s price. The opposite obviously happens when yields rise. The German 10-year benchmark bond yielded 0.07% on 20 April. However, rather than slowly but steadily returning 0.07% per year, this bond returned -7% over the next seven weeks.

‘Bond returns are more driven by yield changes than by the level of yields’

ond returns are thus mainly driven by yield changes and the resulting price changes of the bond, rather than by the level of yields. Volatility in bond yields offers opportunities to benefit from strong returns, but clearly also risks in times of rising yields. Decent returns can thus still be made in the current environment, provided one is able to capture the gains in strong market episodes and protect against losses in weaker periods. This is precisely what Robeco Lux-o-rente aims for.

Active duration management

Robeco Lux-o-rente takes outspoken duration positions. It can reduce its duration (interest-rate sensitivity) strongly to offer protection against rising yields, while it can also increase its duration to benefit strongly from falling yields. The active duration positioning is fully based on the outcomes of Robeco’s proprietary quantitative model. The fund is currently at its lower duration bound, offering maximum protection against the sell-off in early June. 

Robeco Lux-o-rente sold its exposure to EMU bonds in the last part of February. Improving growth, the stabilization in inflation expectations, the unattractive valuation and the turning trend in global bond markets all contributed to this decision. The fund thus was immune to the entire rise in Bund yields. With ensuing decisions to sell Japanese and US bonds as well, the fund offered maximum protection against the new leg of the sell-off in June.

Figure 1. Lux-o-rente duration (blue, left-hand axis) and German 10-year yield (right-hand)
Source: Robeco, Bloomberg

Figure 1 shows the duration positioning of the fund over the past year. The blue line shows the fund’s duration. With a high duration, the fund aims to benefit strongly from falling yields; with a low duration, the fund aims to be protected against rising yields. The duration of the global government bond market has hovered between 7 and 7.5 year over this period. To illustrate bond market developments, the orange line shows the German 10-year bond yield. 

The fund thus successfully navigated bond markets over the past year. The fund had a maximum overweight position for most of the period from late July 2014 to the end of January this year. The fund thus benefited strongly from the resulting bond rally, delivering almost 11% return over this six-month period. By reducing its exposure to bond markets since February, the fund has limited the losses from rising yields. Robeco Lux-o-rente could thus hold on to the strong performance gained over months before.

Robeco Lux-o-rente EUR DH share, Performance figures gross of fees, based on Net Asset Value; All figures in EUR, Inception date September 1994. Source: Robeco Global Performance Measurement. The value of your investments may fluctuate. Results obtained in the past are no guarantee for the future. 

The past year nicely illustrates both sides of Robeco Lux-o-rente’s active duration strategy: it benefited strongly from the bond rally until the end of January, and after that maintained its return by protecting against the bond sell-off that occurred in recent months.

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