For the Citywire + rated manager, this dearth of opportunities has been exacerbated by its benchmark – cash. When central banks are artificially suppressing interest rates, his peers can escape criticism as long as they keep in step with the index, but as an absolute return manager, Eigen has nothing to hide behind, he has to make a gain.
Eigen, who has run the absolute return fund since 2007, returned 4.65% in US dollar terms over the calendar year of 2014, while his average peer in the Citywire Alternative Ucits – Bond Strategies sector gained 5.7%.
‘As opportunities for fixed income shrink you have to remember the benchmark for us is cash. It has been since we launched 2007 and it will never change,’ the Boston-based manager says.
‘The only way to make money in fixed income last year was to bet on interest rates going from all-time lows to new all-time lows.’
Eigen says playing that sort of game was never part of his plan and for much of the past 12 months he’s preferred to sit on the sidelines.
‘If you have a benchmark that invests in rates, you will buy Swiss 10-year bonds at minus 50 if your benchmark does that, because you are more a price taker than a price maker. When your target is beating cash, that sort of trade isn’t an option. Last year I didn’t want to own or short rates.
‘To my mind, the rates markets in all developed economies are fundamentally broken. They don’t react to anything other than central bank statements and central bank actions, and that’s pretty much it.’
Flicking the switch
Eigen finally came off the sidelines in the closing months of 2014 as his cash pile headed towards record levels. In 2011 he held as much as 85% and for most of last year he wasn’t too far behind at between 65-70%. In a rather bittersweet comment, he says the pressure of keeping so much money off the table was at least eased a little by redemptions from the fund which saw it drop from $10.2 billion to $7.02 billion between March 2014 and January 2015.
But Eigen saw his moment to change things. ‘If the opportunity set shrinks incredibly, if spreads are very tight, if volatility is very low and there aren’t a lot of good information ratio trades out there, I am going to increase cash. I was as high as 65% or 70% in cash in the middle of last year and then coming into January, I was as low as 40%.
‘I spent a lot of money in November and December on the energy sector, idiosyncratic trades and the high yield market, tapping into widening spreads. Also, I was taking advantage of ongoing bank deleveraging by investing in commercial mortgage-backed securities and commercial real estate opportunities.’
While these trades, Eigen says, may have dragged down his year-end numbers, particularly as the energy sector was broadly impacted by plummeting oil prices, he is standing by his actions.
‘You had a hiccup in energy at the end of the year, which is going to cause some defaults downstream but not in the near term. In the near term it just creates incredibly attractive prices,’ he says, having bumped up his exposure to this market from zero to 2-3%.
‘A lot of these securities can withstand a $40-$50 oil price for quite a long time. We have seen them adapting by cutting rig counts in the US. We’ve also seen exploration and production firms reducing headcounts to absorb declines in capex.’
Elsewhere, Eigen has made a significant shift into high yield bonds, which flies in the face of his earlier stance on the sector. He initially cut his allocation by half at the start of 2014, after telling other investors to prepare high yield ‘exit plans’.
However, he then redoubled his position to 33% over the final quarter of 2014 in what appears to be an opportunity that was too good to miss.
‘Regardless of what the falling oil price did, in a normal environment we would have expected senior bonds in high yield energy names to have gone down five to 15 points, they didn’t do that. They went down 15 to 40 points because the liquidity was so bad,’ he says.
‘We were buying bonds I had no interest in at par. We were picking them up at 50 or 60 cents on the dollar and these are companies that have years of runway before they would have to do something in response to even $40 oil.’
He was also drawn into areas he had never quite imagined investing in. Eigen bought his first high yield ETF and also ventured into Venezuela.
‘I looked at it and said: “Right Venezuela has a problem currency, they will probably have to devalue at some point, but they have the largest oil reserves in the world, which is reasonable collateral.”
‘Bonds went down to 30 cents on the dollar from 50 but I think they can get back to 50 pretty easily, maybe even 60 or 70.
Eigen says these positions are not taken to generate short-term outperformance but are designed to aid longer-term performance. Something, he says, which will become increasingly complicated as the role of fixed income and the dynamics of bond markets change.
‘Just by virtue of what has happened to rates, which are very close to zero globally, the definition of what fixed income is has altered,’ he says.
‘Fixed income was once a counter-cyclical measure for your portfolio which you could depend on when the risk was off. Those days are over.’
Not everyone, as Eigen has learned, is on board with this theory though and he recounts a heated discussion with a ‘grouchy’ gentleman on a flight to Florida when his fellow passenger purported to know more than the JPM manager when it came to fixed income.
The stranger in question was a bond investor who predicted bond markets would have an even better 10 years than the excellent decade that just ended. It was time for Eigen to speak up.
‘I finally couldn’t help myself and I said no they won’t. It is not my opinion, it is mathematical.
‘He got very upset and said I didn’t know what I was talking about. So, I thought there is your average retail investor in the US, who owns 50% of his portfolio in fixed income and you have to ask what is going to come of this?’
For Eigen it is about being positioned for the long haul and not jumping whenever central banks click their fingers, even if it causes short-term shocks. ‘I will never be right on time, I am always early,’ he says.
‘I am the guy that turns up at the party 20 minutes early and leaves an hour and a half before the last keg is rolled out. That only ends with pain in the morning. We are trying to do the same thing we have always done.’
This table shows that the JPM Income Opportunity fund, while classified as an absolute return fixed income strategy, has the hallmarks of a broader high yield bond fund. However, it operates with almost half the volatility of its more traditional high yield peers.
Nearly half of the fund’s systematic risk comes from unexplained sources, which suggests idiosyncratic risks are one of the key threats to the fund. Financials account for almost a third of the fund’s systematic risk, while energy makes up about 10% and materials 7%.
The strategy’s unique approach makes it hard to compare with other bond funds. Asia Pacific ex Japan and emerging Europe present the biggest geographic risk, while the US, which has been a traditional hunting ground for Eigen, equates to only a marginal percentage in systematic risk terms. Raw performance figures indicate the fund has had a tougher time than its peers over the analysis period.
François Chauvet founded APTimum in 1995, a service company dedicated to risk measurement and a representative of SunGard-APT. He has acquired a broad experience in risk: on the practical side, implementing tools and assisting more than 75 clients in the asset management area; on the theoretical side through research into VaR, TaR and extreme phenomenons. He has also lectured in various Universities and developed a funds classification system based on APT’s risk analysis. In 2006 he founded FUNDCLASS, a rating agency, which applies this methodology to 240,000 funds (www.fundclass.com).
This article originally appeared in the March issue of Citywire Global magazine