Q: What is the history of the fund?
The T. Rowe Price Global Multi-Sector Bond Fund launched in December 2008 during the worst of the financial crisis, almost to the day that high-yield spreads peaked.
Two years earlier when I joined the firm, one of the first things I worked on was developing a global fixed-income strategy. At that time, most multi-sector strategies were centered on U.S. fixed-income, as there had been a series of emerging market crises through the 1990s in Latin America and Asia that restricted their growth.
We wanted to provide an alternative to traditional U.S.-centric core and core-plus strategies by creating a fund that used the full global opportunity set, with greater exposure and flexibility across the capital structure.
Following the fund’s launch, many emerging markets have increasingly put their financial houses in order. Credit quality has increased, allowing countries to issue more in local debt. As a result, there has been dramatic growth in emerging market corporates, emerging market sovereigns, and emerging market local bonds – growth which has opened global opportunities for multi-sector portfolios.
The fund seeks income and potential capital appreciation. It is widely diversified, and we are active in our use of tactical allocation among domestic and global debt instruments – government and corporate bonds, mortgage-backed, commercial mortgage-backed and asset-backed securities, and convertible bonds. Assets under management are approximately $346 million.
Q: How would you describe your investment philosophy?
Our philosophy has four key tenets: using the full global opportunity set, investing tactically, basing decisions on our in-depth global research capabilities, and always remaining risk aware.
First, it is our belief that the more an opportunity set is limited, the more return opportunities are limited. The fund has a wide opportunity set, across both the globe and capital structure, while still maintaining a level of diversification.
Second, active tactical allocation is used to take advantage of changing global risks. We want to have significant flexibility to go in and out of sectors and countries as opportunities change.
Third, our global research platform feeds the top-down view as well as bottom-up analysis, and we believe both contribute to return. For example, when the strategy began, a top-down call was made to overweight credit sectors as we were coming out of the financial crisis. Once spreads normalized and the credit beta trade went away, it became more of a security selection market, which fit our bottom-up credit capabilities.
By providing bottom-up ideas, our global research platform adds value by helping with security selection across the corporate, securitized, and sovereign credit markets, with dedicated coverage by country and industry.
Fourth, the portfolio was designed to be diversified and avoid excessive concentration in any one sector. We diversify not only by sector, but also by source of value-add and by investment theme. In environments where it pays to take risk, the fund invests in some of the higher-risk, high-return sectors. When the converse is true, tactical moves are made into safer, more liquid holdings.
However, just as I would not characterize the strategy as being based solely on credit sectors; neither is it solely based on rates or currencies. We diversify exposures, so if something unanticipated happens, the fund is less likely to experience large drawdowns and losses from one source of return.
Q: What is your investment strategy and process?
We set aside one week each month to look deeply into global economics, global interest rates, global sectors, and forex (FX). During this policy week, we analyze what central banks are doing, the outlook for global inflation and growth, what will drive rates and markets globally, and which countries might be attractive. Sectors are also examined, with each sector team providing input about their area’s fundamentals and technicals, and where value can be generated.
With this information, our base outlook on the global economy is formulated to assess whether it is a good period to take risk. After identifying key risks – perhaps oil, inflation, China, or central bank policy – we forecast spreads, currencies, and interest rates, using bottom-up evaluations from our analysts. Finally, these forecasts are charted on a risk-return plot with conviction levels.
The risk-return plot gives portfolio managers a framework for discussion with analysts on where to find value. We debate the risks around return opportunities, and develop trades and themes to express in the portfolio.
This process leads to several actions: trades to implement now, trades to initiate at a target level, and themes to track until a market event happens or valuations change. Trades are implemented through our global trading platform.
Following implementation, weekly strategy meetings are held to assess the portfolio and market changes, and revisit themes to corroborate our thesis. We also pace the timing of purchases so as not to be disadvantaged by pockets of market illiquidity.
Q: How do you find opportunities with the help of your research process?
Our holdings are rated internally; analysts provide ratings on the credit securities and countries we are investing in, along with their conviction levels.
We rely on sector teams for best ideas on security selection. For instance, if I want to add 3% to high-yield, I would have discussions with the high-yield team on “best ideas” from our analysts, whether to transact in new issue or secondary markets, sizing of positions, and then our global trading team would handle execution.
Right now, interest rates are low in developed markets, so if you want yield, it is necessary to look in credit markets or emerging markets. While value is not always evident at the sector level, our analysts look to unearth opportunities within specific sectors or issuers.
Currently, we have higher conviction on emerging market local country bonds because countries that are easing policy are generally more attractive. The U.S. is expected to tighten policy in December, while emerging market countries like Brazil, Russia, and Indonesia are actually in or nearing easing cycles. After considering the policy views of country analysts and the risks, we decide whether to invest based on valuations.
Risk management is crucial because risks between different parts of the portfolio can be correlated to a specific factor, so it is important to remain cognizant of the factor risk across the portfolio.
Take oil, for example, whose price reverberates across economies, sectors, countries, and currencies. The portfolio will react differently to oil producing countries (Russia) versus oil consuming countries (Turkey) as oil prices change. It’s the same for companies that produce versus consume oil. Oil prices also impact currencies and interest rates. So one factor can have a broad impact across the portfolio, which means it’s important to have a risk management system that can quantify those risks at the factor level.
As a global portfolio manager, I look at how factor risks come together at the portfolio level, and ensure our risk is lined up with our conviction level on the outlook for each factor. And when we invest, we determine where risk is most attractively priced – for instance, would it be better to invest in emerging market local bonds or on the credit side to get exposure to a specific factor?
So while our research and analysis unearth opportunities, risk management informs the portfolio construction.
Q: What is your portfolio construction process?
Though building the portfolio is part science, a greater part is art – we arrange the pieces so that our highest conviction ideas take on the highest tracking error. Overall portfolio construction is greatly driven by the return per unit of risk, while positions are also scaled based on our level of conviction. When our analysts have high conviction on a country or credit, we want more tracking error to come from there rather than from an idea with lower conviction. We carefully analyze correlations. On a more basic level, sector and country diversification are considered, as is risk in terms of sources of return – how much is coming from currency, interest rates, sector allocation, credit spreads, and credit security selection.
Deeper down, we evaluate the risks and tracking error around each of our portfolio themes – for example, tightening Fed policy, a China slowdown, or weaker oil – as well as the risk coming from every security. When considering an addition to the portfolio, we have the ability to look at how it may impact the overall portfolio risk and examine each of the factor risk components within the trade.
The portfolio has broad latitude and is focused on cash bonds. While we are not a heavy user of derivatives, if we want to get into a sector quickly or are considering a short-term play, we will sometimes do so through credit, interest rate, or currency derivatives.
The number of holdings is targeted at 200 to 400 though we prefer closer to the lower end of the range. Some are longer-term holdings that form a core position of sorts.
We have sector-based maximums and can go up to 65% in below investment-grade, but rarely have we approached that level. High-yield credit can range from zero to 40%, emerging market local from zero to 40%, and global sovereigns from zero to 50%. There are 5% limits on issuer holdings. Countries are not limited by specific maximums, however we take more latitude in higher-quality countries because they have less of an impact on portfolio risk.
Our benchmark is the Bloomberg Barclays Global Aggregate ex Treasury Bond USD Hedged Index, a dollar-based benchmark that excludes global treasuries. Excluding Treasuries makes the index tougher to beat from a yield standpoint. It was initially selected since the strategy is more credit intensive than investment grade benchmarks, but we have the flexibility to go into currencies and interest rates to supplement these exposures. A base holding for the fund would not be a Treasury bond but more likely a higher-yielding credit type of security, even though we can and do hold global Treasuries particularly in times of risk.
Q: How do you define and manage risk?
We talk about risk in terms of diversification, factor risk, risk at the portfolio and security levels, and overall volatility.
There is not a set strategy or target to avoid drawdowns or negative returns because the portfolio is valuation driven and looks beyond the short-term. However, we are cognizant of this and take shorter-term volatility only if we believe it will lead to longer-term gains.
Though risk models certainly have their place, they also have limitations – they cannot tell us what will happen when a real-life financial crisis strikes.
Instead of using models to identify the tail risk in the portfolio, our approach relies on internal scenario analysis which allows us to see how the portfolio would perform during historical events like the global financial crisis, extended tightening cycles by the Fed, or past oil crises. I believe such scenario analysis gets us closer to the real answer on tail risk.
Not only do we look at risk assuming correlation benefits, we also look at it assuming everything is 100% correlated. This gives us a risk number based on normal circumstances and one based on a stressed scenario – with the real risk number likely falling somewhere in between. Together, our analysis of scenarios and fully correlated risk gives us a solid understanding of what our downside might be in an extreme risk event.
Liquidity risk is something else we are always aware of, because if a crisis hits, the portfolio must have enough liquidity to deal with it, and we want liquidity to take advantage of tactical opportunities during a crisis. We will hold higher-quality securities, global Treasuries, and agency mortgage-backed securities for liquidity as opposed to less liquid areas like emerging market corporates, bank loans and lower-quality sectors, which are more return generators. When buying into these sectors, it is critical that we are getting paid for liquidity risk. Also, when investing in less-liquid sectors, it is important to have a longer-term horizon because we cannot trade in and out of them quickly.
