ZPSLLC Global Bond Manager Assessment and Insight-Part Four

Our last piece on the emerging market debt segment of the larger global bond market focused on ETFs that we believe are not appropriate for most investment firms given the complex nature of this area of the capital markets and the nuanced construction of the various products. 

We would like to introduce two active managers that possess two very different profiles although they are both under the world bond umbrella. These funds possess some of the characteristics of the ETFs we described in our last two investment briefs on developed and emerging market Exchange Traded Funds.  

American Century International Bond Fund (BEGBX)-$1.1 Billion in assets

This funds’ goal is to provide exposure to non-dollar, non US government and corporate debt. Since they limit the funds hedge back to dollars at 25% it has the highest chance of reasonable performance when the dollar has periods of weakness.

Characteristics

  • Benchmark-Barclays Global Treasury Index-ex US
  • Duration 6.76 with an SEC Yield .69%
  • Credit-AA or better
  • Derivative use-Yes
  • Process-Yes, although the results have not been compelling given the number of portfolio managers and analytical tools.

Zenith Thoughts

This fund needs to change its mandate to expand its opportunity set as the index it mirrors has a very low yield and is heavily tilted to developed country’s bonds. Top ten holdings include a large percentage in Japan where rates are abysmally low and the UK which are also not compelling.

While they have added value at times, their adherence to a low performance potential index hamstrings this management team significantly. Even if interest rates do not move against this fund, there is simply no reason to pay for a yield of .69%. If they do move against the current positioning, it would be a negative return. The major chance that this fund has for capital appreciation is for serious disinflation in the major countries in the fund so that real yields become more attractive and the bonds have the chance to go up in value.

Given the serious complexity of the global bond and currency markets and the limited scope of this fund, we would recommend that investors sell this holding until this area of the market offers a better risk to return scenario or they have a solid thesis on the funds underlying holdings and believe that the management team can extract value.

Templeton Global Bond Total Return TGTRX-$8.3 Billion in assets

While this fund is not new to many investors, it is worth reviewing for its stark contrast with the American Century fund. The opportunity set is much wider for this fund as it can invest in government debt of any nation, supranational entities, corporate debt including convertible and preferred debt, private placements, and municipal debt.  The holdings can be any maturity and any denominated in any currency.

  • Benchmark-Citigroup World Bond Index
  • Duration 1.8 with an SEC Yield 2.99%
  • Credit-They are able to take advantage of lower rated bonds for higher income and possible appreciation due to a credit upgrade.
  • Derivative use-Yes
  • Process-Yes, robust and the results have been very strong long term although they have had a tough time in a tough market over the last year or so.

Zenith Thoughts

This fund has a wide mandate and the willingness to go well off benchmark regularly is key to their process and results. These results are not without volatility but by working within a defined risk budget among its segments of risk, they are able to mitigate a decent amount of the extra risk that accompanies these markets.

They have done well over five years as they have produced average annual returns over 8% while American Century only a little of 4%. Both managers face difficult bond market dynamics as monetary policy is changing here in the US and around the globe.

The underlying thesis for this fund lies in the global variation in monetary policy. They believe that the G-3(US, Europe and) continue to undertake very loose monetary policy which renders the value of the currencies lower than fundamentally stronger Emerging Market currencies.

This is important to note since this is a global bond fund and yet they are morphing into an emerging market bond fund by virtue of their thesis. They do however maintain much more flexibility than pure emerging market funds as they can hedge back into the dollar to the extent they believe is appropriate.

We believe that the American Century Fund is not worth the cost as it has not done very well in the past and is not equipped to take on the dynamics of the global bond market in the future. Templeton has the resources and a dynamic mandate to mitigate some of the risks inherent in the global debt market while capturing value over time. This fund is one of the global debt funds that we would place in the lineup for your investment committee.

Sincerely,

Tom Koehler, CIO

 

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