Q: What is the history of the fund?
The fund was established in September 2012 and is based on the belief that many bond benchmarks ultimately reward bad behavior. The more indebted a country or a company is, the higher its weighting in the benchmarks is, and that’s counter to what you would expect from fixed income investing.
That’s why we created a fund that is not managed to a benchmark, but is oriented towards total return. We use the entire global fixed income universe, which is about $100 trillion in total, and try to find the best available ideas without adhering to a benchmark.
This is a global bond fund that aims to leverage the entire JPMorgan asset management fixed income platform. We can invest in anything and we cover the entire fixed income spectrum, including sovereign bonds, investment grade and high yield corporate bonds, all forms of emerging markets, sovereigns in local currency, all forms of mortgage, including asset-backed and commercial-backed securities, collateralized mortgage obligation, and agency mortgages.
Having a dedicated investment team across all those sectors, allows us to make sure that we get the best global ideas in one main portfolio. The total JPMorgan platform runs over $450 billion in fixed income markets and has more than 200 investment professionals, including managers, credit analysts, and traders. We try to use all these people and their ideas into one “best ideas” product.
We run the same strategy across the U.S. and Luxembourg. Recently, we launched a U.K. version as well. We run both the onshore and the offshore versions through the mutual fund process. Collectively, we manage about $3.5 billion in the Global Bond Opportunities Fund.
Q: How do you define your investment philosophy?
There are three main aspects of our philosophy. Our philosophy is based on three main tenets. First, we believe that fixed income markets are globally integrated. The different sectors are no longer isolated. As a result, it is very important to be aware of what is going on across all the sectors to have a good grasp of the underlying risk. Basically, you need a global footprint to grasp the fixed income mandate.
For example, to understand the developments in emerging markets debt, you need not only to understand the policy of the specific country, but also the developments in U.S. monetary policy.
Second, we have a strong belief that every single bond we buy should be researched in house and there should be accountability from someone on our platform. For every single investment, someone has effectively recommended and approved the idea as this is a research-driven fund.
Third, we truly believe that we are lenders of our clients’ money. Ultimately, we want the invested money back and we want it back with interest. That approach is reflected in the research process, which makes sure that the money is coming back for every single bond. We make sure that we are very confident in our decisions.
Q: How do you transform this philosophy into an investment strategy?
We employ both a top-down and a bottom-up approach. The portfolio management team makes the fixed income allocation decisions. We decide if we want to be in corporate high yield in the U.S. or in investment grade bonds in the U.K. or in emerging markets debt.
Once we make these decisions, we allocate capital to the underlying sector teams. They are the ones with the expertise to decide which company to buy in investment grade credit, for example. The sector teams do the bottom-up security selection.
Q: What drives your asset allocation?
We have a disciplined, consistent, and repeatable investment process. On a quarterly basis, Bob Michele, the global CIO of the fixed income platform at JPMorgan Asset Management, holds a meeting to bring together the senior portfolio managers and the sector heads of all the different strategies. We go through each market and sector as all the teams present their markets. We discuss the previous quarter, what we got right and what we got wrong.
We all come up with scenarios and estimate the probabilities around those scenarios over the next quarter. I think of this meeting as the roadmap for how the global fixed income team at JPMorgan sees the world over the next three months.
Then, on a weekly basis, the sector teams meet to challenge or reinforce that view. A key feature of the fund is that we link ourselves by talking about the different markets through a common language. Every single sector team talks through its individual market independently, but uses three filters – fundamental, quantitative, and technical. They break down their markets through those three filters and then, once they have their independent meeting, they bring their views to a global forum.
So, every single week we discuss what the sector teams have generated, how they are positioned, what they think about their markets, where they see the opportunities, their profits or losses, etc. That global meeting is where the portfolio management team starts making decisions on allocating capital among sectors based on their attractiveness.
The common language of fundamental, quantitative, and technical aspects is crucial, because it allows us to effectively compare the sectors, which compete for the assets.
Overall, we are fixed income asset allocators deciding where the opportunities are across the entire fixed income marketplace. After the global forum, the portfolio management team meets to map our return expectations and confidence level for every single sector. That global heat map represents the basis for capital allocation.
So the allocation decisions are in the hands of a three-member portfolio management team. Bob Michele is our Global CIO and the lead portfolio manager alongside Nick Gartside and me, who is our International CIO. In addition to listening to all the different teams and understanding their thinking and ideas, we also use many quantitative tools.
Ultimately, however, the allocation is a judgment call between the three of us, based on where we see the opportunities and how much risk we should take.
Q: How would you describe your research process?
We rely on the individual teams for the research. The government bond team analyses its market; the credit team analyses the credit market; the high yield and emerging market teams are the experts in their respective areas.
For example, the government bond team would analyze macroeconomic data, growth trends, inflation expectations, and other key drivers. They try to get a sense of how central banks would react over the coming weeks and months, because that would be a big driver for the markets. ?hey also look at the quantitative side and examine how the securities are valued and if there is mispricing relative to our expectations for the central banks’ decisions.
Finally, they also focus on the technical side, which can include many things. Currently, the supply/demand dynamics in the government bond space is interesting. In the fourth quarter, there are about $500 billion bonds bought by central banks through quantitative easing, and that will affect the overall yield levels as currently central banks around the world are buying more government bonds than the governments are issuing and that will have a big impact on the market.
Sometimes valuation is a big driver. Spreads could be very wide, but if we see a real deterioration in credit quality, they can easily go wider. Likewise, government yields could be low, but if the global economy goes back in recession, those yields could go even lower. So, valuation definitely plays a part, but we also look at the fundamental and technical aspects.
Q: How do you handle the current low interest rate environment?
One of the benefits of our strategy is that we are not attached to a benchmark. We do not have to own bonds with negative yields just because they are part of the index. Instead, we can choose the areas where we still find value from the entire global fixed income marketplace.
I think there is still a lot of opportunity across the global fixed income space. Importantly, in our strategy we can move up and down the duration of the portfolio. With index-based funds, you would typically have about six years of duration and that could be quite painful if there is a sharp increase in rates. For example, in the Taper Tantrum of 2013, we had the ability to take the portfolio duration down. Our duration was only around two years and we had less risk to the shock movement of higher rates.
Looking forward our view is that rates are likely to remain low for the foreseeable future, but at some point they will go up and we need to be ready for that. We need to be in the right type of strategy to at least preserve the capital as opposed to suffering big losses that would occur in some benchmark-aware strategies.
Q: What is your portfolio construction process?
Since we don’t have a benchmark, we have more flexibility. We run a diversified portfolio with about 1,000 items at the moment. We believe that diversification is important because of the asymmetric risk associated with fixed income securities. When you buy a security at par (100) you want to receive back 100 plus the interest, but in the worst case scenario, if the company folds, you may get back almost nothing.
That big asymmetric difference between the best and worst case scenarios in fixed income assets makes research and diversification critical. Every single bond that we buy is thoroughly researched in house, and we also have diversification to protect ourselves in the event of companies that fail to deliver.
As I said, the three portfolio managers do the top-down sector selection and then we allocate capital to the individual teams. For example, at the moment we have allocated about 17.5% to investment grade credit. We have discussions with our global investment grade team and they advise us whether to be investing in the U.S., Europe, or the U.K. and what is the best current market for investment grade credit. That team also does the underlying bond selection.
I believe that the decision on individual securities is best placed with the credit analysts, because the portfolio managers look at the macro environment across the entire space. The combination of details on individual companies, their relative value, and where the opportunities are, is best analyzed by someone who effectively spends each day looking at these companies. So, the credit analysis team makes the specific bond picks for the portfolio, because they do the research, they know exactly what we are buying, and are better prepared for these decisions.
Q: How do you define and manage risk?
Risk is one of the most important factors on the portfolio side. Historically, people always invested in benchmark strategies, so the main risk was the benchmark. Of course, there was some manager risk, but much smaller. A manager could affect the performance with 0.5% or 1%, but if the benchmark went down 5%, the fantastic job of the manager wouldn’t matter.
Since we don’t have a benchmark, the risk shifts entirely to the manager. So my colleagues and I need to make the clients comfortable that we know what we are doing and that we take the portfolio risk very seriously.
We look at risk through several different filters and, in the end, we have a so-called sanity check. One of the aspects is the overall portfolio volatility. We look at both the historic volatility of all the different sectors and the diversification benefits of owning them. So we are always cognizant of the diversification and the correlation between sectors.
Of course, historic analysis has its limits, because it is not always going to be an indicator of future events. That’s why we spend a lot of time on the worst case scenario and we also examine the worst amount of volatility we could be running.
We use the volatility analysis tool on a pre-trade basis. If we make a decision to shift the portfolio, we first run the change through the volatility analysis tool before the execution. We also examine the shape of the overall portfolio, including correlations, beta and other market metrics.
Another aspect is duration, the current yield levels and the risks associated with changes. When pulling off the different ideas from the global market space, we need to know if we are happy with the overall portfolio once everything is combined together.
