Q: What is the history of the fund?
The American Century Global Bond Fund is a multi-sector, multi-country, and multi-currency bond fund launched on January 31, 2012, which primarily invests in sovereign, corporate, and securitized instruments. Following its inception, as the firm’s fixed-income capabilities expanded, and therefore so has our investment universe.
Our initial holdings included investment-grade and high-yield securities with a bit in emerging markets. Now, because we built an emerging markets team and enhanced our rates team, the portfolio has greater investments in that sector.
Unlike many of its peers, the fund is a hedged portfolio. Although on average, 60% of its assets are invested in non-U.S. securities, a large majority of that foreign investment is hedged back into U.S. dollars. As a result, our offering is really a core bond fund with significantly reduced currency volatility compared to others in the space.
The fund began with roughly $25 million in capital. In four and a half years, assets under management (AUM) have grown to $1.2 billion. We have an additional $200-$300 million in AUM through satellite products with similar mandates. Our sister fund, the American Century International Bond Fund, has just under $1 billion AUM; its U.S. exposure tends to be more limited than the Global Bond Fund and the portfolio is unhedged so its underlying assets have full currency exposure.
Q: How would you describe your investment philosophy?
We believe in two main tenets: the bond markets are inefficient and a portfolio must have diversified sources of return.
Because of inefficiencies in bond markets, market trends tend to be mean-reverting. To capitalize on these, we use active management and emphasize diversified sources of return, including country, currency, sector allocation, and bottom-up individual security selection.
Our aim is to achieve strong risk-adjusted returns, particularly over the medium and long term – periods during which we believe return is primarily driven by fundamentals.
Q: What is your investment strategy and process?
Because this is a diversified portfolio that follows multiple and complex markets, we capture value using input from bottom-up sector teams as well as a top-down strategy team. Separating these responsibilities allows us to better understand the many aspects of fixed income, cover a larger investment universe, and emphasize strong security selection skills
Specialized sector teams cover rates, credit, securitized debt, and municipal bonds. These teams are our bottom-up alpha generators that look at market trends, analyze individual securities, and actually construct the portfolio for their respective sectors.
A global macro strategy team comprising the senior sector leaders is responsible for top-down decisions concerning duration, yield curve, and sector allocation. Our perspectives on global trends, inflation, and possible event risks are woven through daily conversation and more formal communication.
Looking out six months, we believe growth will be moderate at best, although it should be steady and sustainable as long as there are no policy mistakes from any of the major central banks.
One event risk we are paying attention to is the December 6, 2016 Italian referendum. On the slate are constitutional and political reforms, which potentially could dissolve the country’s government, replacing it with a non-traditional political party.
The rise of non-traditional political parties can pose significant event risk. Though it is unlikely the Italian government will fall, were power granted to another party, it may not be as friendly toward the European Union or might replace existing policies with more progressive ones. Regardless, we expect to see volatility as the event nears.
A more obvious risk is China, which has seen growth decelerate over recent years, a trend we believe will continue. In our best-case scenario, growth will stabilize around 6% to 7% using the official GDP projections.
However, we do not see this as a major destabilizing risk over the next six months, as our belief is the Chinese are managing it well. We still keep a close eye on China, given the country’s importance – the knock-off effects of its economy are felt by the rest of Asia and the developing world.
Q: How is your research process organized and where do you find opportunities?
Our research process combines quantitative tools and qualitative judgment. Quantitative models provide us a sense of market trends and drivers, but because they do not capture all the variables, qualitative judgment must be applied.
We start with a global macro scorecard that tracks trends across multiple countries in areas like business conditions, growth factors, employment, and inflation. This helps us understand the global economy and how individual countries compare to each other.
To unearth areas that perhaps the models did not capture, we step into the qualitative space and examine political developments and broad factors such as fiscal and debt trends.
Using our qualitative judgment may lead us to invest or overweight a country relative to others. For instance, within the developed global markets, a major recent theme has been low inflation with rates ranging from 0% to 1% depending upon the country.
However, Norway has been somewhat out of the ordinary, with inflation over 3%. We analyzed our models and discovered its higher inflation was fueled by the depreciation of the Norwegian Krone as the result of the decline in energy prices at the end of last year and into early this year. The rise in inflation resulted in the Norwegian bond market underperforming versus core markets like Germany.
Because energy has rebounded 50% to 60% in various markets there is room for the currency to appreciate, which should lead to lower inflation and improved bond market valuations. The fund has invested in different types of four-year and five-year securities in Norway that yield roughly 1%. It also sold negative-yield Germany bonds, which are now negative 50 basis points.
Clearly, today’s negative rate environment is challenging for global bond investors. We use a number of tactics to boost yield, but always stick to our discipline. When good opportunities can be found, lower- or negative-yielding government securities are sold.
Though we do not chase yield for the sake of it, our investments can go slightly down the capital structure to boost yield, buying lower investment-grade and in some cases high-yield bonds primarily in the U.S. Right now the portfolio is overweight high yield by about 7% in the U.S. and 1% in Europe, for a total of 8%.
We also have an overweight in the securitized area, having sold higher-quality collateralized bonds to go down to BBB-rated bonds that offer more yield, like non-agency collateralized mortgage obligations and commercial mortgaged-backed securities.
As with yield, risk is never added just for the sake of it. Currently, the fund is running at about 55% of its overall risk budget because this low-yield environment has reduced the number of opportunities.
Because spreads narrowed in 2016, we are sitting back and keeping some powder dry. As volatility returns over the next several quarters, we will look for assets with long-term value.
We do not invest in the preferred market, but do make significant investments in the U.S. securitized market. Using this sector is common among pure U.S. managers, but our global peers tend not to focus here. However, it is one of our strengths and differentiators, and as such, the U.S. securitized market represents one of our largest investments – currently we are 12% overweight, and it is approximately 30% of the overall portfolio.
Ultimately, security selection involves finding names we like which will offer yield pickup over government securities, while sticking to our general theme of diversification by going into multiple asset classes.
Q: What is your portfolio construction process?
Only after due diligence does an individual security make it into the portfolio. We perform ample research until we feel comfortable from both credit and rates perspectives, and are confident about the structure of the bond.
Because diversification is key to our investment process, it is vital to portfolio construction. We layer our investments in multiple strategies: yield curve management, duration management, sector allocation, country allocation, currency management, and individual security selection.
The fund’s benchmark is the Bloomberg Barclays Global Aggregate Bond Index. It is multi-country and multi-sector, contains only investment-grade securities, and has roughly 60% non-U.S. investments and 40% U.S. investments.
Generally, 50% of portfolio attribution comes from the bottom-up strategies like security selection and sector allocation where, for instance, we may be overweighting corporates relative to government securities. The other half comes from macro decisions like the overall duration of the portfolio and what countries we invest in. Finally, we employ a currency overlay and view currencies as a portfolio basket.
The number of holdings varies, increasing when we allocate more into individual credits and securitized strategies, and decreasing when holdings are of higher quality or when we take risk down by concentrating investments in government securities.
A key risk measure we use is contribution to duration (CTD) from a country standpoint. In general, an individual country could be overweight or underweight in a range from a one-tenth of year of CTD to half year of CTD.
High-yield and emerging market sector allocations are typically between 5% and 20%. Our securitized overweight ranges from 5% to approximately 25%.
Q: How do you define and manage risk?
Because we are active managers, overall risk management is embedded into our processes from beginning to end. We watch three major risk factors: market value, CTD, and tracking error volatility.
A risk budget for tracking error is assigned at a level appropriate given the objectives of our clients. To ensure proper diversification among the portfolio’s different alpha drivers, we then assign a risk budget to individual investments.
Currently, though the fund has a risk budget of 250 basis points of tracking error relative to its benchmark, we are only running about 125 basis points because we think spreads are tight and country opportunities limited. Going forward, though, our expectation is for increasing volatility, and should this happen, we will take risk higher and capture the spread widening.
While we use tracking error volatility to measure risk on the entire portfolio, we use market value more in the credit space – particularly for high yield and emerging markets, where we need to know the absolute market value exposure for each security. Contribution to duration is used with higher-quality securities, be they investment grade corporate bonds or government securities, as CTD is more of an interest rate risk measure.
