Carmignac’s Charles Zerah presents a flexible bond fund able to deliver true diversification within the fixed income universe
WELCOME
The Carmignac Portfolio Unconstrained Global Bond fund invests in a variety of fixed income assets and is managed in a truly unconstrained investment style. Fund manager Charles Zerah, alongside head of fixed income Rose Ouahba, explains how they take an active approach to investing in global bonds - including government, emerging and corporate bonds, as well as currencies – to maintain a portfolio that is able to react to market events as they occur. Assisting Zerah in his search for market Alpha, head of credit Pierre Verle reveals Carmignac’s conviction-driven approach to fixed income investing and how both top-down and bottom-up market analyses have helped the fund to succeed.
THE INTERVIEW
The goal of generating performance in varied market environments is embedded in Carmignac Portfolio Unconstrained Global Bond’s investment process. It is why we need to be as unconstrained as possible
Charles Zerah & Rose Ouahba,
Carmignac Portfolio Unconstrained Global Bond
* Morningstar Rating™ : © 2017 Morningstar, Inc. All rights reserved. Source: Carmignac. As at 28 April 2017. Past performance is not necessarily indicative of future performance. The return may increase or decrease as a result of currency fluctuations, for the shares which are not currency-hedged. Performances are net of fees (excluding possible entrance fees charged by the distributor). Reference indicator represents JP Morgan GBI Global (EUR) index
*Reduction in dollar allocation refers to Carmignac Patrimoine.
Changes in markets have disrupted traditional investment models ever since the global financial crisis nearly a decade ago. Geopolitical events in particular have continued to test investors who want to outperform a benchmark.
It is a challenge that the fixed income and credit teams at Carmignac know only too well, having launched the Carmignac Portfolio Unconstrained Global Bond fund in December 2007. The Carmignac Portfolio Unconstrained Global Bond fund is completely unconstrained in its nature. With no regional or benchmark restrictions, it invests worldwide in government, corporate and emerging market bonds as well as currencies. Zerah also has considerable leeway to adjust the fund’s modified duration – including to negative levels – and invest up to a percentage of the fund in distressed assets, convertibles and credit derivatives too.
Macro analysis
A team of 11 assist Zerah on the Carmignac Portfolio Unconstrained Global Bond fund, including the group’s head of fixed income, Rose Ouahba, and head of credit Pierre Verle. Together the management team prioritises risk above anything else. The fund currently sits at a risk level four out of seven, with 50% of its assets rated as AAA. Head of fixed income Rose Ouahba explains: “We try to avoid risk; whether it is in reference to Brexit or global elections we will try to reduce it in our portfolio as much as possible before utilising our investment toolbox to achieve our return objective. We are quite different from our peers because while they may have a mandate to beat the benchmark, we instead look to actively manage the risk profile of the fund.”
This cross-sector and holistic analysis approach, alongside the fund’s flexible investment philosophy, aims to achieve a return higher than the JPM GBI Global index across a minimum two-year horizon. So far, the fund has achieved this. It returned 31.3% over a five-year period versus 19.4% for the benchmark and 21.6% against the Morningstar Global Bond peer category.*
Carmignac is recognised for its top-down know-how, which is the foundation of its investment style for this fund as well. The strategy starts with macro analysis and the entire management team, including CIO Edouard Carmignac, gathering each morning to debate, discuss, and establish their market views. “We analyse a range of global macro scenarios on a quarterly basis but we also have a lot of daily input from the team and our CIO. This helps shape our convictions about where we invest and how we react to market changes” explains Zerah. “We also use a bottom-up approach that enables us to look for alpha generating strategies specifically. Our team of analysts is composed of asset class or strategy specialists that provide strong expertise in their field and a 360 degree view of the opportunities in the fixed income universe. The team strive to opportunistically identify broken asset classes and inefficiencies in the market to seize trends and boost performance.As such, we have a lot of interaction between bond and equity managers at Carmignac, which is very different to how our peers invest.”
Performance hedges
In terms of hedging against currency risk, Carmignac’s macro stance shifted at the beginning of the year and the team has brought down its dollar exposure in some of its fixed income strategies. Ouahba explains: “Positive reflation trade following the election of President Trump was reflected in our high US dollar allocation in the fund.” “However, we changed our view at the beginning of the year as we observed the dynamism of European assets and the sharp acceleration of inflation that was being seen in the region. This saw us reduce our dollar allocation to 5%* in some of our strategies (versus the benchmark’s 40% allocation) because if the dollar depreciates, I want my clients not to feel that [in terms of any capital loss]. Zerah agrees: “For Carmignac Portfolio Unconstrained Global Bond, the goal of defending our clients’ capital is embedded into our investment process and that is why we need to be as unconstrained as possible with this mandate.
There are three primary drivers the fund manager uses to enhance performance within this fund: interest rates, currencies and credit spreads. Zerah has the ability to hedge against rate risk, credit risk and currency risk. He explains: “Take interest rate risk, for example. We are very flexible and have the ability to turn negative on modified duration (anywhere between -4 and 10), something that since I have been managing the fund I have used extensively. Today we are close to zero modified duration in the fund as we hedge against rate rises globally.”
In Zerah’s fund, the portfolio’s current positioning assumes that inflationary pressures and bond market tensions are likely and he is being extremely careful with the fund’s allocation to sovereign debt. “In our current allocation, we are short hedges on the United States and Europe, especially Germany and the United Kingdom. We have invested in emerging markets and corporate issues with the aim of generating some performance for us, and also have plenty of cash, which we are investing in short-dated US Treasuries. This lets us balance our investment strategies and experience less volatility.” Zerah adds: “We are always looking for the best assets, with an advantageous risk premium, that can help us guard capital and deliver rolling returns for the long term.”
-4 - +10
FUND DURATION RANGE
Potentially higher return
HIGHER RISK
Potentially lower return
LOWER RISK
4
7
6
5
3
2
1
FUND'S RISK SCALE
FUND OUTLOOK
How has the Carmignac Portfolio Unconstrained Global Bond fund performed?
Carmignac Portfolio Unconstrained Global Bond: Performance
For example, in the fourth quarter of 2016, the manager had positioned the fund in expectation of pressure on bonds, which mounted after the US election due to fiscal policy plans and the potential for reflation in the United States. The result was that the fund gained over 1% while its reference indicator lost more than two points. Carmignac Portfolio Unconstrained Global Bond fund has shown itself to be a resilient choice for investors seeking performance at a time when yields remain at extreme lows.
Charles Zerah’s freedom of movement allows him to avoid any bias, and to withdraw from an asset class completely if necessary. But the fund’s main difference is its flexibility, as it can adapt its modified duration (-4 to +10) to avoid any negative repercussions of higher interest rates.
Zerah explains the rationale behind this move: “The synchronisation of global growth and inflation, and the positive outcome from a number of European political events this year has been a welcome surprise and we believe countries such as France and Italy could now see an acceleration of growth.” “However, we also believe the European Central Bank will soon start to turn hawkish and start preparing for tapering next year. Therefore, we want to be prepared. Currently, we are cautious about rates across the fund, especially in global bonds.” Zerah is currently employing a number of hedging strategies, including shorting futures, 10-year and 30-year Bunds and shorting 10-year Gilts as well. “We are still, and I should add we believe we will stay for some time, in a very low yielding environment. But we also realise we are coming in for an adjustment at a central bank level after a very long time of accommodating monetary policy in Europe. We are reflecting that in terms of modified duration in our portfolio.”
Modified duration has played an important part in the Carmignac Portfolio Unconstrained Global Bond fund ever since it was launched, and over the past 18 months in particular. In S1 2016, the fund’s average modified duration was at eight, while today it sits at less than 1.
This accumulation fund invests worldwide, in currencies, corporate bonds and, in particular, government bonds from both developed and emerging countries. Charles Zerah has managed the fund for seven years, during which time these three investment types have generated an annualised net performance of nearly 7%. This return can be attributed to the fund’s absolute flexibility. The fund manager does not hesitate to distance himself completely from the reference indicator, the JP Morgan GBI Global index. Risk management is a core facet of the investment process in the Carmignac Portfolio Unconstrained Global Bond fund and this strategy has enabled the fund to keep volatility below 5% of late, compared with 6% to 8% historically.
(1) A EUR Share Class (2) JP Morgan Global Government Bond Index (JNUCGBIG), coupon reinvested (3) Morningstar Rating™ : © 2017 Morningstar, Inc. All rights reserved. Source: Carmignac. As at 28 April 2017. Past performance is not necessarily indicative of future performance. The return may increase or decrease as a result of currency fluctuations, for the shares which are not currency-hedged. Performances are net of fees (excluding possible entrance fees charged by the distributor).
Carmignac Portfolio Unconstrained Global Bond: Strong Long Term Track Record
Overall
Five years
Morningstar rating
Carmignac Portfolio Unconstrained Global Bond +31.32%(1)
Reference Indicator(2) +19.49%
Source: Carmignac. As at 28 April 2017.
Fund’s modified duration changes
Number of positive periods over five years
31
38
29
22
Number of negative periods over five years
Source: FE. As at 30 May 2017. All data as at last month end. Data refers to Carmignac Portfolio Unconstrained Global Bond F GBP ACC Hedged in GB. Past performance is not necessarily indicative of future performance. The return may increase or decrease as a result of currency fluctuations, for the shares which are not currency-hedged.
Monthly Carmignac Portfolio Unconstrained Global Bond fund performance versus benchmark
Annual downside risk versus benchmark and peer group
JPM GBI Global GBP
IA Global Bonds
Charles Zerah, Rose Ouahba & Pierre Verle,
Carmignac
The challenge of investing in bonds in today’s low yielding environment continues to plague investors; how do you combat this challenge?
The threat of interest rates rising quickly in the coming period suggests investors should protect their portfolios against rising rates in the main developed countries and generally calls for unconstrained, opportunistic bond management
Emerging market debt still appears to offer interesting opportunities, supported by Chinese macro-stabilisation, commodity price rebounds, improving current account balances of some emerging countries, and attractive yields versus developed countries
Opportunities can still be found within international bond markets. Indeed, we have made emerging market sovereign debt and commodity credit key components of our portfolio so as to reap the benefits of the emerging world’s economic vibrancy
Charles Zerah, Rose Ouahba and Pierre Verle on the opportunities and challenges for fixed income today.
Where are the best opportunities in global bonds today?
Nevertheless, opportunities can still be found within international bond markets. Indeed, we have made emerging market sovereign debt and commodity credit key components of our portfolio so as to reap the benefits of the emerging world’s economic vibrancy. Furthermore, we maintain an allocation to subordinated debt in the European bank credit segment and European CLOs.
For several months, we have felt that due to a combination of historically low absolute yields, a likely pick-up in global inflation, and political risks in Europe, the bond markets in developed countries have little to offer us. They are suggesting that investors should give portfolios a very cautious level of modified duration in those geographies.
The fund has a strong allocation to emerging market debt, what are the drivers for this allocation?
However, selectivity is key in an environment that continues to be volatile. Evaluating each country and corporate risks and opportunity set is fundamental to singling out the best stories in this asset class.” Moreover, we believe that commodity exporting countries should continue to offer attractive risk premiums in comparison with manufacturing countries in emerging markets.
Emerging market debt still appears to offer interesting opportunities, supported by Chinese macro-stabilisation, commodity price rebounds, improving current account balances of some emerging countries, and attractive yields versus developed countries.
Can you explain the fund’s exposure to the energy and financials sector?
The threat of interest rates rising quickly in the coming period suggests investors should protect their portfolios against rising rates in the main developed countries and generally calls for unconstrained, opportunistic bond management, providing all of the leeway needed to tackle difficult markets and seize opportunities.
On the credit side, although reduced given tight valuations, we maintain an allocation to the European bank debt segment as well as commodity related corporate bonds. Firstly, bank credit of national champions across the capital structure should outperform as the multi-year trend of de-risking, deleveraging, and re-regulating banks works to decrease the excessive systemic discount still in bank credit spreads. In particular, the banking policy shift from taxpayer funded bail-outs to unsecured creditor funded restructuring and resolution should drive increased bank risk differentiation and flight to quality within the periphery. The ECB’s suppression of risk premia across the eurozone’s non-bank investment grade credit market ought to force investor rebalancing into our favourite bank themes. Secondly, commodity-related corporate bonds remain attractive as they should benefit from the pick-up in commodity price.
Indeed, there is no doubt that some parts of the market are expensive as hyper-active central banks with unconventional policies have forced investors, via the portfolio rebalance channel, to make greater investment risks than they otherwise would have done. This has reduced risk premia across all asset classes. Nevertheless, our unconstrained approach allows us to find value on certain fringes of the market. We are convinced that a flexible and opportunistic-based strategy with active risk management is essential to find the best risk-adjusted opportunities in order to outperform.
What is the future for fixed income investing as rates and inflation begin to rise?
In the current scenario, where various factors such as the improving economic cycle, the switch from monetary to fiscal stimulus, and the presence of various political hazards, all pose a challenge to investors wanting to generate performance while overcoming the risks to bond markets.
FIXED INCOME Q&A
'A flexible and opportunistic-based strategy with active risk management is essential to find the best risk-adjusted opportunities today’
Pierre Verle
Rose Ouahba
Charles Zerah
CONTACT US
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Carmignac Portfolio Unconstrained Global Bond A EUR Acc (ISIN: LU0336083497) is a share class of the sub-fund of the Carmignac Portfolio Sicav. Ongoing charges: 1,20%. Performances are net of fees (excluding applicable entrance fees acquired to the distributor). This is the performance of the Euro share. The fund has other shares in other currencies.This document is intended for professional clients. Promotional material – Source: Carmignac at 31/03/2017. This document does not constitute a subscription offer, nor does it constitute investment advice. Access to the Fund may be subject to restrictions with regard to certain persons or countries. The Fund is not registered in North America, nor in South America. The Fund has not been registered under the US Securities Act of 1933. The Fund may not be offered or sold, directly or indirectly, for the benefit or on behalf of a U.S. person, according to the definition of the US Regulation S and/or FATCA.The Fund presents a risk of loss of capital. The risks, fees and ongoing charges are described in the KIID (Key Investor Information Document). The Fund’s prospectus, KIIDs, NAV and annual reports are available at www.carmignac.com, or upon request to the Management Company, or for the French Funds, at the offices of the Facilities Agent at BNP PARIBAS SECURITIES SERVICES, operating through its branch in London: 55 Moorgate, London EC2R. This material was prepared by Carmignac Gestion and/or Carmignac Gestion Luxembourg and is being distributed in the UK by Carmignac Gestion Luxembourg UK Branch (Registered in England and Wales with number FC031103, CSSF agreement of (10/06/2013). The KIID must be made available to the subscriber prior to subscription. For more information, please contact our local team: CARMIGNAC GESTION LUXEMBOURG – UK Branch - 22a St James‘s Square,London SW1Y 4JH Tel. : (+44) 0207 360 6100
