By Hamlin Lovell, NordicInvestor
Jupiter’s Head of Strategy Fixed Income, Ariel Bezalel is looking at a global investment universe – spanning investment grade corporate debt, high yield corporate debt, developed market government debt, emerging market sovereigns and corporates, currencies and interest rate derivatives. Asset allocation amongst these sub-asset classes rotates around according to his macro views.
Currently, Bezalel’s of the opinion that the US economy is late cycle, and recessionary risks are on the rise. “On the cusp of the longest economic expansion in history, the odds are stacked against you”, he says, enumerating, “global PMIs are around 50; the economic surprise index has turned negative, especially in Europe; total debt is up to 272% of global GDP from 235% in 2007; there is record US corporate leverage; loose covenants as in 2007-2008; US auto loan delinquencies are on the rise; the slowest growth in broad money M3 since 2011, and flat or inverted yield curves globally”, as multiple warning signs.
Though emerging markets are clearly growing much faster than developed markets, he points out that weaker economic numbers from countries surrounding China are a better barometer of China’s economy than the country’s own statistics. He expects China will disappoint on the growth front and underwhelm on the stimulus side of things, which reads through to Europe and especially Germany.
Betting on rate cuts
Bezalel’s big bet is interest rate duration of 7,5 years, which is above most peers in the unconstrained bond space, as seen in the Morningstar Global Flexible Bond EUR Hedged Sector (in which Bezalel’s Dynamic Bond is ranked 2/37 funds since launch in May 2012) – and is a big uplift on the one-year duration he has run only around 3 years ago. Roughly two thirds of the duration exposure today come from developed market government bonds, of which the US and Australia represent the largest positions.
He expects a sharp rally in government bonds based on the “Japanisation” thesis: that Japan’s ageing demographics make it the template for Europe and America, which are only nine and eleven years behind Japan in terms of population ageing. Japanese ten-year Government Bonds and German ten year Bund yields are already hovering around zero and he expects that other sovereign securities could converge towards this level. Bezalel sees scope for a US rate cut in the second half of 2019 and thinks that Australia could cut rates even more aggressively – ultimately to zero – to avert a ‘hard landing’, as “the lucky country is running out of luck”. According to Bezalel a credit crunch is unfolding in the housing market and lending in general, after no recession in 28 years. Banks have curbed credit after a Royal Commission investigation found that mortgage lenders failed to properly verify incomes for lending. In addition, consumer debt to GDP is the highest in developed markets, even above Ireland’s peak pre-crisis levels. “It’s very common to find people in Australia with two or three of four properties, and heavily levered. Fourth quarter GDP eked out only a 0.2% gain, falling short of population growth, meaning there was in effect a per capita recession”, says Bezalel. A long position in Australian government debt, with currency risk hedged, is a core exposure for the strategy with around a 17% weighting. It also has a much smaller holding, around 1%, in somewhat less liquid New Zealand sovereign debt, where the central bank has also turned to a dovish bias. Bezalel is aware that other property hotspots, such as Canada and Sweden, may also be rolling over, but they do not share Australia’s catalyst of a bank credit squeeze.
Emerging and corporate carry
The portfolio is running a barbell approach with around half of the book in the aforementioned ‘AAA’ rated debt to profit from a deflationary shock, while the other half is intended to earn some carry and capital gains from corporate and emerging market debt, biased towards shorter dated paper: the portfolio’s credit spread duration is down to 1.5 years.
Emerging market exposure has been pared back to 15% from 20% as Bezalel finds it challenging to predict emerging market volatility amid multiple elections in Argentina, India, Israel and India this year. Russian debt appeals as the country has a very low debt to GDP ratio, and he feels that Gazprom debt is highly unlikely to be sanctioned given its importance for EU gas supply. Neighbouring Ukraine has just issued some very short dated paper with mid to high single digit yields that Bezalelfinds compelling, based on his anticipated election outcome.
In corporate credit, Bezalel aims to garner capital gains from special situations, on top of carry income. Amid a downturn in poultry pricing, he bought into a second lien note from poultry producer, Simmons Foods, at around 70 cents on the dollar. The bonds have already rallied to 88, and he expects they will eventually reach par. The fixed income team of 12 investment professionals has developed a good dialogue with the management of this family-owned, private company, including a site visit in Arkansas to inspect improved facilities.
Another special situation is oil services group Topaz Marine, which operates offshore support vessels (OSVs) on long term contracts for customers such as BP and Chevron in the Caspian Sea, Middle East and Africa. The 2022 debt offers a high single digit yield to maturity and the company’s commitment to deleveraging could be accelerated by an IPO.
Though the book will not go net short of credit overall, it can be short of segments such as European and US corporate credit at present. Bezalel sees, “the US investment grade market as a ticking time bomb as companies ramp up leverage to buy back debt and a record proportion of half the IG index is now rated BBB.” Zombie businesses are being kept alive by low rates. “We do not necessarily expect defaults but do expect more downgrades. Kraft Heinz, Anheuser Busch, Campbell Soup and GE are examples of companies that are have been downgraded”.
There is a tiny position in a convertible bond from precious metals miner Sibanye, which is part of a gold sector bet that includes bonds of Iamgold, which pay a yield of 6%. Bezalel expects gold could benefit if central banks reinvent the wheel on easing rates and resume QE, and could also benefit from USD weakness. For now, however, he has a slightly long USD position, structured by not fully hedging USD exposures. There are no other currency bets in the portfolio currently.
Bezalel’s defensively positioned as he believes markets are complacent about risk. He is also on the lookout for interesting entry points in emerging market debt, short duration credit and special situations that may arise from a selloff.