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Decline
Duration significantly reduced, lowered emerging markets exposure

Duration significantly reduced, lowered emerging markets exposure

29-11-2016 | Insight

Following the bond market sell-off after the US election Robeco Global Total Return Bond Fund has made some changes in the portfolio. Portfolio manager Kommer van Trigt explains the recent adjustments in the portfolio.

  • Kommer van Trigt
    Kommer
    van Trigt
    Portfolio manager, Head of Global Fixed Income Macro

Speed read

  • Duration reduced to 4.4 years
  • Emerging market local currency exposure reduced to around 3%
  • Short position in Italian government bond futures

Global bond markets have sold off strongly following the election of Donald Trump as the new US president. Investors are anticipating that Trump’s announced infrastructure spending and tax cuts will result in stronger US economic growth, higher inflation and higher budget deficits. Higher growth and rising inflation prospects will also encourage the Federal Reserve to hike short-term rates.

As illustrated by the graph, ten-year US Treasury and UK Government yields rose substantially after the US elections, whereas we saw a more moderate rise in German ten-year 10-year yields barely moved up as the Bank of Japan’s yield-curve control measures have effectively kept government bonds yields low.

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Source: robeco, Barclays Live

Duration reduced

“Following Donald Trump's victory, we shortened the duration of Robeco Global Total Return Bond Fund from 6.7 to 4.4 years to limit the negative impact of rising bond yields on the portfolio return”, says portfolio manager Kommer van Trigt.

The dynamic nature of the fund’s investment approach, investing in government and corporate bonds in both developed and emerging economies across the world, makes it possible to react quickly to volatility in bond markets. Van Trigt: “We can actively adjust the duration of the portfolio within the one- to ten-year range. This enables us to limit losses when interest rates rise and maximize profits when they fall.”

Lowered emerging markets exposure

Trump’s victory is bad news for emerging economies. He not only announced withdrawal from trade agreements, he also intends to raise import barriers for imports from cheap labor countries to stimulate the US manufacturing sector and create jobs. Being very dependent on exports to the US, Mexico will most likely be hit hardest. With investors expecting Trump’s anti global trade policies to heavily weigh on emerging market economic growth, emerging market currencies plunged while bond yields in many emerging countries rose.

“Given the more negative outlook for this universe, we have reduced emerging market local currency exposure from 7% to 3%”, explains Van Trigt.

Short position in Italian bonds

In the run-up to Italy's referendum, in which the Italians will vote on constitutional reforms and the political fate of Prime Minister Matteo Renzi, Italian government bond yields have risen considerably. The spread between 10-year Italian and German government bonds is wider than it was just after the Brexit referendum. Investors are not sure what to expect. A ‘yes’ for reforms is what the country needs, but based on the polls the ‘no’ camp is ahead.

Driven by political uncertainty, Van Trigt took a short position in Italian government bond futures. “That's now paying off. In the last few years, Italian government bonds outperformed. But for the first time in years, they are now substantially underperforming the Eurozone government bond market with negative total returns year-to-date. However, we do not expect Italian government bonds to reach 2012 peak spread levels as ECB buying will prevent Italian government bond yields rise too strongly. This was not the case in 2012.”

Not necessarily higher global growth and inflation

The election of Trump has shifted investor focus from a world of low growth, low inflation and low interest rates to an environment of stronger US growth, higher inflation and rising yields. “While we acknowledge that the US will embark on a path of more fiscal spending, tighter monetary policy and therefore higher interest rates, we do not think this will necessarily also result in higher global growth and/or inflation”, says Van Trigt.

“The Eurozone and Japan are still stuck in a low growth and low inflation environment, while Trump’s announced anti global trade policies will negatively impact growth in emerging countries. The divergence in economic and monetary policies will provide ample opportunities for the Robeco Global Total Return Bond Fund to employ its active duration, country allocation and credit strategies to generate returns while limiting drawdowns from rising bond yields.”

“Our short position in Italian government bond futures is paying off”