PRESENTER: For an introduction to AXA Investment Managers Global Strategic Bond Strategy, I’m joined now by lead fund manager Nick Hayes and investment specialist Jack Stevenson. Nick, let’s start with you, how would you describe the strategy, what’s the main objective?

NICK HAYES: So the strategy’s a long-only global fixed income strategy, which is designed to sort of combine the best of government bonds, high quality credit and lower quality credit or high yield emerging markets in order to deliver attractive risk-adjusted returns or, probably better said, attractive bond risk-adjusted returns.

PRESENTER: Jack, a number of providers have got strategic bond funds and strategies, what’s the USP of this one?

JACK STEVENSON: So really we think that the world is far too complicated without needing to complicate your fixed income allocation. So really what we try to deliver is a core bond allocation that has a very clear distinct approach with three risk buckets that break down that global fixed income universe. So you have all your interest rate sensitive assets in your defensive bucket, your high quality credit in your intermediate bucket and then we call the lower quality credit and the default light risk our aggressive risk bucket. So we think that adds a lot of transparency to our approach and helps clients to navigate through what can be quite a complicated world and indeed quite an opaque sector at times.

PRESENTER: And within that approach, where do you look to add the most value?

JACK STEVENSON: So really I think where we can add value is as a fixed income outsource. What you are getting through a strategic bond fund is trusting us to manage your entire global fixed income allocation within a holistic fund, and I think where we as a house can add value is the scale and depth of AXA IM’s fixed income platform and resources that we have. We have offices around the world that are managing individual, local fixed income strategies, and where we try to add values by bringing that all together within a single strategy and also by helping clients through the investment cycle to navigate through a lot of the uncertainty that is out there, without needing to worry too much about how they asset allocate or manage things like duration. So that’s really where we try to add the most value.

PRESENTER: And so what metric should investors focus to judge whether or not you’re hitting your objectives and over what sort of time periods?

JACK STEVENSON: I think the first thing we always say is that clients are the best judge of whether we’re doing a good job or not, and each will have their opinion on that. But a few ways in which we look at it are first of all are we delivering those attractive risk-adjusted returns over the time horizon that we set out, which is an economic cycle. Now clearly you don’t really know how long an economic cycle is until after the event, but we tend to think of it as being maybe a three or five-year time horizon. So we tend to first of all look at our absolute performance over that time horizon: are we delivering those sort of attractive risk-adjusted returns with hopefully that lower volatility than most? Second of all clearly we look at how we’re performing versus individual asset class sleeves, because I think that’s helpful for clients to understand if they were to allocate to an index in the areas of government bonds, credit, high yield emerging markets, how would that perform on an individual asset class basis compared to the kind of performance that we can deliver through the diversification of fixed income. And finally we do look at the competition.

It’s a competitive space. So we do monitor how other funds are doing, how the broader peer group is doing. But as I think it’s clear in this sector, it can be quite a broad sector. So we really try to have the bigger picture, the market picture, and sometimes we look at individual competitor funds. But, you know, we’ve been doing this now for 10 years and we haven’t changed the way we do it, nor will we change the way we do it based on what others are doing. But it’s a helpful reference point.

PRESENTER: And, Nick, over the last 12 months interest rates have up extraordinary amount compared to the last 10, 20 years, how are you managing duration on the portfolio, how active is that, what are the costs?

NICK HAYES: So duration management is obviously a big key and it’s the biggest driver of arguably any bond investment. But the way we do it we set out that we have a wide leeway. So we can have an overall aggregate strategy level, anything between zero and eight years as an overall duration exposure. And the way we manage that is both through asset allocation. So obviously by nature of asset allocating away from government bonds into credit or high yield, that would probably bring down your duration exposure. But also secondly and very importantly we use government bond futures. So we can use government bond futures which is a very liquid and simple instrument to increase or decrease the allocation or the duration sensitivity to the investment strategy.

So we use duration a lot. We have the zero to eight years of allocation, and given as you suggested last year was a pretty complicate and reasonably painful year, we actually had everything from zero years of duration to six years of duration. So we are reasonably active there and we think that’s a key driver of delivering those attractive risk-adjusted returns.

PRESENTER: Jack mentioned a little earlier that you’ve got three risk buckets within the portfolio, how active are you in moving between them and how quickly can you do so?

NICK HAYES: So the three risk buckets are incredibly important and what we have is, as Jack has said, we have the high quality government bonds, the high quality credit and then the high yield and emerging markets. We have limits as to what we can and can’t own. So we can’t have more than for example 60% in high yield and emerging market. That ensures that we have good diversification across global fixed income. And then at an asset allocation level where we might be moving our duration up or down by one or two years at a time, if we’re re-asset allocating from high yield because it’s more attractive out of government bonds or credit, that would be a 3 or a 5% move at any one time. But I think the way to think of it you have strong diversification across the three risk buckets, you have the potential for reallocating across those three buckets, but also there’s a lot going on within each of the sleeves.

So within our high yield allocation, even if we haven’t changed the allocation, it’s entirely possible to be going more defensive and owning a lot more short duration high yield assets, or alternatively you could be going more aggressive and owning lots of longer dated or even lower rated. So there’s a lot going on. It’s a combination of the structural diversification that’s afforded to us by the global universe. Secondly the three risk buckets and the ability to asset allocate. But let’s not underestimate the stock picking and the sort of individual names that are going into the strategy, so it’s a combination of all those three.

PRESENTER: But would you always have a certain amount of the portfolio in government bonds regardless of what else is going on?

NICK HAYES: Absolutely I think, you know, we talked a lot about attractive risk-adjusted returns. That means decent return with a relatively low volatility. Now having government bonds, which traditionally have a very low if not negative correlation to equity like assets such as high yield or emerging markets, by having that strong diversification across those different types of asset classes, means you deliver a relatively low volatile type return. So yes having an exposure to government bonds whether they be long dated and relatively risky or very short dated, lower yielding and therefore less risky, I think it’s very important to have some government bonds alongside your diversified global credit.

PRESENTER: There’s been a real rise in passive investing in the last decade, what’s your thoughts on this active/passive debate when it comes to fixed income?

JACK STEVENSON: I think firstly I’d like to emphasise that the strategy we manage is very much active and dynamic. It’s not to say that a passive approach isn’t suitable for certain investors who want certain outcomes. But I think it’s also worth emphasising a degree of caution over how these indices that passive investing follow are structured, a lot of the time these indices are rules-based, and often they overweight a lot of the most indebted issuers within the index. So it sometimes skews the composition of that index and has certain biases. Now that’s not necessarily a bad thing. It’s just about trying to understand really what you’re getting out of that index. A global aggregate index, for example, is going to have a higher constitution of government bonds than credit.

So you’re going to end up with more duration than you would get in necessarily an active unconstrained strategy like a global strategic strategy, whereby we are moving that duration around quite flexibly and dynamically. And lastly I’d emphasise the rise of ESG that I think is very important to certainly our investor base and clients generally, whereby I think with an active approach we’re really able to show and demonstrate the ESG capabilities that we have in terms of how we’re looking at the different issuers and filtering them by ESG risks and opportunities and really building that within the portfolio. I think with a passive investment case, you’re not necessarily getting the same approach. Also when it comes to engaging with the issuers in which you invest and to try and influence them to adopt better carbon transition, metrics for example and net zero targets or whatever it might be.

So I think a combination of all of that means that an active approach for us is the best way to navigate through an uncertain environment and also get that ESG integration built into the strategy.

PRESENTER: And what are the resources that you can bring to bear on the fund, Nick? How do you operate and interact with the team, how do you go about making investment decisions?

NICK HAYES: So AXA Investment manager’s a big global investment management house. We have a huge capability in global fixed income. We have investment team members based in London, Paris, New York and Hong Kong. And the idea of the strategy is to bring the core strategies of those global ideas into the one fund. Clearly that requires quite a lot of people. That requires a big team effort. But simplistically we kind of break it down to a global central team. Four of us based in London where we have the overall responsibility for constructing the portfolio, taking responsibility for the performance and certainly doing the investment grade and duration management. Then we carve it out to local teams who have local management expertise in for example high yield and emerging markets.

So those teams are busy picking the stocks. They are using their global analyst capability to put the high yield or the emerging market names into the portfolio. So it’s obviously one strategy, but it’s made up of a number of different investment sleeves in order to combine the best ideas for a global organisation.

PRESENTER: We’re talking at the start of 2023, so what do you see as the main threats and opportunities for the year ahead?

NICK HAYES: So, look, we’ve come off of a very difficult 2022. Fixed income returns have been big, minus double digits in some places. You’ve seen very high inflation, the kind of inflation we haven’t had for a number of decades, and central banks have been very behind the curve and are now aggressively tightening interest rates or tightening financial conditions to combat inflation. That’s not typically a good environment for fixed income. However, if you start to think about where we are today, that we’re looking at an asset class that is providing a yield that we haven’t seen for many decades, so government bond yields are only between 3, 4, have sometimes been close to 5%, and then if you add on a credit spread of a couple of hundred basis points or get into even more attractive high yield and emerging markets, you can get to yields of nearly high single digits if not double digit yields.

So the outlook for fixed income I think is particularly attractive. It’s come off of the back of a difficult year, but I think the outlook for returns for ’23 and ’24 is that you can arguably look at high yields that you haven’t seen for a while. If those yields return into returns, then you’re looking at sort of equity like long-term returns for fixed income risks. So that is pretty attractive. The threats I guess are a continuation of what we’ve seen in 2022. We still have high inflation. We think that central banks have done a lot to combat that inflation. We’re starting to see a peak in inflation. Maybe people are starting to speculate that central banks have done the vast majority of the job in raising interest rates but who knows. If inflation stays very stubborn, if inflation goes even higher, then interest rates have going to have to put up rates again.

So the opportunities are pretty obvious. We’ve got attractive yields, we’ve got attractive spreads, the all-in return potential for fixed income is very high, but as ever with investing there is threats, and there is the risk that maybe ’23 turns out a little bit like ’22. So we kind of expect some volatility, we expect some decent returns, but the underlying carry or the underlying yield on a fixed income portfolio is now more attractive than it has been for many years.

PRESENTER: After the repricing of fixed income in 2022, it does feel like we’re in a very different regime and environment, does that change the way that you think about fixed income as an asset class.

NICK HAYES: So it certainly doesn’t change the way we manage the assets. The idea or the strategy as we’ve said is about combining high quality government bonds, with credit and high yield, in order to deliver attractive risk-adjusted returns. But what is definitely different is that we’re now in a very different environment of much higher yields than we’ve seen for quite a while. We’re an environment where we don’t have the support of central banks. So for the last 10 years or so we’ve had QE. We’ve had central banks being a huge buyer of government bonds and credit, and that’s brought yields low, so we’ve had to work pretty hard to deliver a decent return. We’re now in a very different environment where the threat of inflation or the reality that we have an environment of sort of sustained and possibly stubborn inflation is with us. I think that takes a different mindset.

You have to be less reliant on central banks. But at the same time we’re being compensated for that. So yields are attractive. The carry on the portfolio is pretty attractive. So we have to think about bonds in a slightly way that you’re running yield is going to carry a lot of return, but then you still have the potential for volatility and you have to think that the dispersion on offer, the fact that high yield now goes into double digits and government bonds are sort of high to mid-single digits means there is much more opportunity.

PRESENTER: So, in summary, why should investors consider strategic bond funds for their portfolio, Jack?

JACK STEVENSON: I think really what investors are getting with their strategic bond allocation is a fixed income outsource managed by a very global team that have core expertise in all the major markets of the world, and indeed from an asset class perspective experts that are managing single sleeves in areas like high yield and emerging markets, we bring that together in a global approach managed by a core team here in London, and that’s helping investors to navigate through a very uncertain world with lots of complexity in a very simple transparent structure.

PRESENTER: Nick, final thought?

NICK HAYES: Look, 2022 was painful, 2023 starts with very attractive yields, very attractive spreads, and I would argue that fixed income is now competitive with other asset classes. I think we can compete in terms of return with equities, for example, but obviously at the same time only taking fixed income risks. So I think the outlook is pretty attractive for fixed income.

PRESENTER: Nick Hayes, Jack Stevenson, thank you for joining us.

BOTH: Thank you.