It wasn’t supposed to be a conversation about why bond fund managers are so scared of rising rates at the moment.
But that was where the conversation ended up when I caught up with New York-based Tom Goggins, senior portfolio manager of Global Multi-Sector Fixed Income at Manulife, and his colleague Kisoo Park, who is in the firm’s Hong Kong office.
Goggins and Park have an interesting vantage point from which to give their views on the potential risks of a bond market sell-off which has become the hot topic in global market, as their firm’s approach to fixed income investing gives them the freedom to invest in any almost any bond market on the planet.
Goggins told Business Insider that Manulife’s approach was “benchmark aware but agnostic”. That means the portfolio managers can pick and choose what markets they can invest in and decide whether they want to be offensive or defensive depending on the market environment.
That approach has allowed Goggins and his team to generate equity-style returns with lower standard deviation over the long term than the universe of fixed income investments in which the portfolio managers buy bonds.
Manulife aren’t in some of the “frontier markets” like Venezuela or Mongolia where investors are forgetting about risk in their reach for yield, Goggins said. But neither did they buy any of the Australian government’s recent gilt edged, AAA rated, blockbuster $7.6 billion 30-year bonds.
They have gone defensive as they anticipate a more hostile environment for fixed income investors across the globe.
So we were talking to the right guys to explain the importance of the recent rise in long bond rates and why it’s got investors worried.
Just this week, the latest Bank of America Merrill Lynch survey of the world’s biggest investors shows that across asset classes, investors are worried the most about a bond-market crash.
Goggins and Parks said it’s all about the mechanics of the way bonds are issued and priced in the current environment compared to past cycles.
“20 years ago the average duration (the measure of interest rate risk to movements in rates) on a bond, or portfolio of bonds, might be 4 years with a coupon of 7%,” Goggins said but added “now the duration is 6 or 7 years with a 1% coupon”.
Put simply, that means that the longer duration on bonds, or a portfolio of bonds, which is a result of the big fall in bond rates across the globe, rates equates to bigger capital losses for even 1 basis point of increase.
But the lower coupon rate the bonds now carry means there is virtually no income buffer from the semi-annual coupon payments to offset the capital loss from rising interest.
It’s why Bridgewater founder Ray Dalio said recently at a New York Fed symposium (emphasis added):
If interest rates rise just a little bit more than is discounted in the curve it will have a big negative effect on bonds and all asset prices, as they are all very sensitive to the discount rate used to calculate the present value of their future cash flows. That is because with interest rates having declined, the effective durations of all assets have lengthened, so they are more price-sensitive. For example, it would only take a 100 basis point rise in Treasury bond yields to trigger the worst price decline in bonds since the 1981 bond market crash. And since those interest rates are embedded in the pricing of all investment assets, that would send them all much lower.
The 30-year Australian government bond which matures in 2047 issued recently has a duration of 19 years. No wonder Manulife didn’t want to buy it in this current environment.
And no wonder global investors are bit freaked out about the potential for a bond market crash.