The three-year lifecycle of Dickie Hodges’ fixed income fund is bookended by two contrasting markets.
In January 2015, the month leading up to the Nomura Global Dynamic Bond fund’s launch, returns for the asset class reached up to 8 per cent, which Hodges describes as “basically most people’s return profile for the whole year”.
In contrast, when we meet in early February, not long after the fund had celebrated its important three-year anniversary, markets are selling off and the benchmark 10-year treasury yield is hovering around 2.8 per cent, a four-year high.
Stronger than expected employment figures from the US, including 2.9 per cent wage increases, triggered concerns the US Federal Reserve might raise rates faster than expected on higher inflation.
Unfortunately for Hodges, who must now navigate his way from the current bout of volatility, his fund missed the astounding returns of January 2015, having launched on the last day of that month.
It is not the first difficult start for the manager: his previous LGIM Dynamic Bond fund launched on the cusp of the global financial crisis in April 2007.
2015 – a most difficult year
“The backdrop for 2015 was a very, very difficult year,” Hodges says of the Nomura fund’s inauspicious start, when markets feared the break-up of the euro on the back of a possible Grexit. “People say bond funds returned zero during the course of that year, but the fact of the matter is that for 11 months they actually lost 5 to 6 per cent.”
Consequently, Hodges stresses the fund’s negative 2.7 per cent in 2015 does not include January. Over the same period, the comparable FO Fixed Interest Global sector lost 2.2 per cent, but that reduces to just 0.5 per cent for the full year returns.
He has since navigated through two major events; Brexit, by buying “everything UK” except the currency in the lead-up, and Trump, through anticipating the reflation trade. For 2016, the fund returned 3 per cent in Q2 and 7.8 per cent in Q4, compared to the sector’s 0.2 per cent and 1.6 per cent respectively.
However, Hodges is excited by the greater volatility he anticipates for 2018 and 2019 because it is the environment he expects to perform best in. The reward/risk ratio on the fund is 1.30 over the last three years compared to 1.19 for the S&P 500 over the same period or 0.25 for UK corporate bonds, according to Bloomberg.
That’s better than almost all major asset classes,” Hodges says. The fund is not permitting direct equity exposure, unlike funds in the Sterling Strategic Bond sector, which can hold up to 20 per cent. However, put options on the Nasdaq 100 and Nikkei 225 have been “in the money” on the back of this year’s equity market correction.
The fund’s duration – its sensitivity to interest rates – finished 2017 at 0.5 years and is now 0.21, the lowest in Hodges’ career. In June 2016, it was 7 to hedge against the possibility of a Leave vote at the EU referendum. Now, the fund has “almost zero” exposure to UK rates, which the Bank of England warned in its February inflation report could rise “somewhat earlier and by a somewhat greater degree” than previously indicated.
Is the future in Portugal?
Put options again come into play to create negative exposure to rising US interest rates. “I bought a lot of puts. Not just enough to mitigate the fund’s exposure, but to benefit from rising yields to generate a positive absolute return,” Hodges says. Credit and currency risk is also managed through derivatives.
In anticipation of rockier bond markets, Hodges has reduced exposure to risk assets such as high yield and financials since September. That all went into cash, which was a substantial 40 per cent of the portfolio at the start of the year, with Hodges deploying around 10 per cent by the time we meet towards the end of the market correction.
“I’ve been waiting for this to happen,” he says. High yield and sovereign debt in emerging markets and peripheral Europe is where Hodges spotted opportunities in the “panicked” sell off. The fund generated “a lot of return” from Portugal last year and currently holds around 10 per cent. “I still think it will go up,” he says.
Eight per cent in Indian Masala bonds – foreign debt denominated in rupees – is one of his largest positions.
Hodges points out they did nothing during the equity sell off in 2016 and have been “one of the most stable financial assets in the world” during February’s correction. Furthermore, they deliver income between 6 and 7 per cent.
Fixed income funds top-selling asset class in 2017
Assets in the fund have nearly doubled since the start of the year from $145.6m to $244.1m, although it is still a far cry from the £2.3bn he ran at Legal & General Investment Management.
Despite many calling time on the 30-year bond bull market, fixed income funds were the top-selling asset class in 2017, taking £14.3bn according to the Investment Association.
Go-anywhere sectors, like Strategic Bonds, which is most akin to the fund, were particularly popular.
Despite Hodges’ impressive track record at Gartmore and LGIM, the fund’s three-year milestone is also necessary for many in the industry to invest.
Over three years, it has returned 21 per cent, compared to 13.9 per cent in the FO Fixed Interest Global sector and 9.6 per cent in the Sterling Strategic Bond sector, FE data shows.
“Everybody still wants to see another three-year track record when you start a new fund. I find it the most bizarre thing,” he says.
2014-present: Head of unconstrained fixed income, Nomura Asset Management
2007-2014: Head of high alpha fixed income, LGIM
1989-2007: Various roles at NatWest Investment Management, which later becomes Gartmore