The potential for an economic storm cloud should be whetting active managers’ appetites, according to a fixed-income fund advisor.
, founding partner and CEO at Lawrence Park Asset Management, believes the current bull market, the second longest in history, has led to complacency as investors put their feet up and enjoy a sustained index rally.
However, he feels that with the economic cycle entering its mature phase amid a rising-rate environment, this is an interesting time for the bond market and active managers.
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He said: “We’ve had a sustained index rally for a number of years and you hear all sorts of stuff about passive investing and robo investing, but that type of rhetoric naturally takes hold in bull markets because lots of people can demonstrate that if you just park money in the index you’ll make money.
“In more difficult, more challenging markets, you can really demonstrate that active management can play a role and add meaningful value.”
Torres said that while it’s hard to predict when or if there will be a major economic downturn, inflation will become a bigger issue, creating an environment that is harder for passive strategies to make money.
He said ETFs, for example, will do what they are supposed to and follow the index. “It’s been a one-way bull market; that’s made people very complacent and comfortable and focused on minimising fees and finding the most liquidity. I do think if you get into a sustained downturn – and I’m not saying that will happen – but if it does, some of the differences between active and passive management will expose themselves.”
Torres believes we are entering an interesting time for bonds with the US tax reforms boosting the perception of economic growth, but he expects inflation to be the next step with economies running close to full capacity.
He said: “If we do find an uptick in inflation, which really has not been an issue for well over a decade, I think we could see some more meaningful rate hikes from central banks and a more meaningful rise in bond yields and that’s potentially a little bit scary.
“The stock-market multiples have relied on extremely low interest rates to justify the high multiples and we could have a little bit of a reversal in the near future. It could actually be the bond yields that cause the fall in stocks.
“I think the rapid fall in bond prices and the rise in yields are making the low dividend yields in the stock market hard to sustain. Now we will get some boost in dividends because of the tax cuts but even so, at some point the stock market rally will end, and if bond yields continue to rise at the pace they are, then it could be a tricky and challenging year for investing all round I think.”
It’s far from all doom and gloom in a rate-rising environment, though, with Torres highlighting the returns available via active trading.
“First of all the buy-and-hold approach to bonds has to be rethought,” he said. “There are viable strategies in a rising-rate environment. At Lawrence Park we run a bond portfolio that maintains a very low interest-rate duration and it tends to derive returns through the active trading of corporate bonds. Our premise is that bond markets are very inefficient because they are not exchange-traded and to a professional portfolio manager, there is a lot of opportunity for profit. We think that a focus on corporate bond credit spreads can yield viable returns even through a rising-rate market.
“A case in point is the month of January. We had returns of about 80 basis points positive when the broad index is down about 1%, so there are ways to make money in bad bond markets.”
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