Andreas Uterman, London-based CIO and co-head of the $499 billion Allianz Global Investors, discussed the unknowns in today's global fixed-income market. Although the US Federal Reserve Bank is tipped to raise interest rates this year for the first time since it began its quantitative easing programme, he expects the bizarre fundamentals underpinning bond markets to remain for some time, which will continue to impact the way fund managers position portfolios. The full interview is available in the May print edition of FInanceAsia.
Q Everybody’s talking about the Fed but a rate hike has been on the cards for a long time. Is a 25 basis points or 50 basis points increase in the federal funds rate really going to make any difference?
A I don’t think it will. Much of that expected increase is already priced into the market. It won’t impact the shape of the yield curve in the US. Nor will it change the dynamics of financial repression and the absence of inflation, not while the world economy’s growth remains below trend.
While the Federal Reserve and the Bank of England will start to reduce their balance sheets acquired through quantitative easing, the European Central Bank and the Bank of Japan are accelerating their QE programmes. The global monetary supply continues to expand.
The fundamental challenge investors will continue to face is that there is no yield to be had, even after the US raises interest rates.
Q That suggests investors will continue to buy spread or equity-like aspects of fixed income, such as high yield and emerging-market debt.
A I 100% agree. Absolute valuations on these asset classes have gone up, but so have relative valuations because company earnings haven’t kept pace.
Q Therefore, do you expect to change your flagship portfolios’ asset allocation?
A We maintain a very diversified book of business, so there’s no answer I can give you. We’re trying to bring to the market strategies for our end clients that provide some yield at a reasonable level of risk. That includes dividend products, more exposure to emerging markets, and tactics such as global currency spreads. These can be volatile and risky, but there’s also value there, particularly in market long-short strategies that generate alpha. The important thing is to identify valuations across all strategies, and really try to participate in any dislocations that may arise.
Q We’ve been in this mode for about five years. How much longer can conditions carry on this way?
A When it comes to fixed income, we are in absolutely unchartered territory. That’s slightly less the case for equities.
Q Does that apply across the board?
A Not to emerging markets. Local-currency debt in Turkey or Brazil or India all yield levels that are consistent with history.
Q For traditional managers, relative performance no longer seems acceptable. What do your clients say?
A It’s definitely about absolute performance, not relative performance. We think beta returns will be lower than historically for the next five years. Alpha then becomes absolute return. There’s been a change in market perceptions: people are looking for outcomes, rather than just being in the market. For example, clients want us to achieve a level of income above inflation – that sort of mandate is growing significantly. Fewer clients are willing to sit back and accept the beta component.
Q As an active manager, if you’re not making big asset allocation calls now, I guess you’re finding returns through a lot of security or sector rotation.
A Yes, there is more rotation in the portfolio now, between securities or perhaps between duration. Overall risk levels won’t change until the world makes a dent in the real stock of debt, and global central banks rein in excess monetary supply. But that day is some way off.
Q More investors are holding cash. Are you?
A Yes, attitudes to cash have changed because the opportunity cost of holding liquidity has dropped. The yield curve is flat, so the opportunity cost of holding cash versus a one- or two-year investment is zero. The opportunity cost has also fallen because return expectations for money-market funds have declined significantly. To take advantage of what I described as long-term opportunities available in the short term, you need to remain liquid; otherwise when there is a disruption, mutual fund managers will be forced to sell when they actually want to buy.
Q You’ve talked about being in unchartered territory for fixed income. What are some maxims to live by in such conditions?
A That’s a tricky question. One is that we are driven more by market dynamics to think more like a private investor. An individual investor’s first priority is not to lose money. That changes the way our industry thinks about portfolio construction, as well as how we buy and sell securities.
The second point I’d make is that this is challenging our ability to anticipate events that were previously unimaginable. It’s hard to do – and then begs the question of what you do in response. But look at the BoJ going full-bore on QE, or the very concept of QE itself, or the concept of negatively yielding German bunds. Even a few, short years ago it would have been almost impossible to [predict] this; people would have called you crazy. But it’s happened.