Whichever side of the fence fixed-income asset managers are standing on regarding the Federal Reserve’s decision to finally raise interest rates from the zero bound, they haven’t had to scramble to adjust to the new reality. Most got their bond houses in order well ahead of the Fed’s rate hike in December, its first since 2006.
But let’s be clear about something. Although they expect the pace of future hikes to be very gradual, which the Fed has emphasized and because they don’t foresee much inflation that would warrant doing otherwise, they warn against hitting the snooze button. Being vigilant and selective may be more important than ever, as exemplified by the recent failure of Third Avenue Management’s junk-bond fund.
Steve Huber, portfolio manager for the global multi-sector bond strategy at T. Rowe Price, with $1.2 billion in assets under management, isn’t troubled that the Fed has begun raising interest rates. It’s a positive for the bond markets, he says, “because it’s been a risk that’s been out there and now it’s behind us,” he says.
What does concern him, he says, is that illiquidity is likely to cause more volatility in bond prices. Also, the U.S. is nearing the end of its credit cycle, so fundamentals are deteriorating a bit. And he continues to be concerned about growth in China. These risks will affect all the financial markets and “fixed income won’t be immune,” he says.
“Guardedly” is how Huber says he’s approaching 2016. His base case scenario is that the U.S. economy will continue to improve and the global economy will work through some of its issues. “The wild card is commodities,” he says. “I think commodities are going to be one of the largest drivers of what happens in the global economy.”
Commodity prices also feed into the credit sector, he says, noting that roughly a quarter of the J.P. Morgan and Barclays high-yield indices is commodity-related.
In recent months, T. Rowe Price has increased its liquidity by reducing exposure to corporate and emerging market bonds and investing more in higher-quality, more liquid sovereign bonds. “This is about as high as we’ve ever had global sovereigns,” says Huber, “and this may be one of the lowest that we’ve had our credit exposure.”
He has approximately 30% allocated across credit sectors, including 7% to 9% in each of three different categories: U.S. investment-grade corporate bonds, U.S. high-yield securities and U.S. bank loans. He’s more concentrated in U.S. credit because it’s offering higher yields and wider spreads than investment-grade and high-yield offerings from the euro zone.
Huber has 30% to 35% in global sovereign debt. Much of it is higher-quality government-related debt in the U.S. and Germany, but some Asian and Eastern European markets are also represented. “You’re getting a little bit of extra yield there, he says, “but are still safely away from the pure credit risk market.”
He also has about 20% in securitized sectors, including agency and non-agency mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities. The agency mortgage-backed and asset-backed names offer liquidity and provide some level of safety and stability, he says.