Fixed income specialist Robert A. Lee has trimmed risk from his short duration strategies to protect against inevitable volatility from Federal Reserve rate rises.
In an interview with Citywire Global, the New Jersey-based manager said his base case scenario is for a marginal increase in rates at the Fed’s September meeting.
This has seen him turn his attentions to higher quality areas of the market, notably high grade corporate bonds, investment grade securitised products (notably commercial mortgage-backed securities) and asset-backed securities.
‘The short duration market, by extension of the high yield component, was difficult over the fourth quarter of 2014 but it is in the process of making a comeback. The next challenge will be the rates rise – or ‘lift off’ on rates – and that is something we are factoring in,’ he said.
‘With its dual mandate, the current thinking is to follow one of two paths, which is to either raise rates early and then do it gradually or to do it later but at a more aggressive speed. With the lessons we have seen in 2004-2006, for example, my belief is it will be a very gradual process.’
Lee, who is a named manager across several funds at the US fixed income specialist, said market consensus is for a rise later in 2015.
However, the polling results at most recent Citywire events suggest some in the fund selection community think it could bleed over into 2016.
‘The Fed doesn’t have to do it this year. The Fed is independent, at the end of the day, and under its mandate it has to do what it thinks is right for the economy. If it isn’t right, be it because circumstances change or existing circumstances aren’t right, it won’t do it.
‘When it last raised rates it was by 25 bps for 17 consecutive meetings between 2004 and 2006 and it was very transparent in that,’ Lee said.
‘Now there are positive and negatives of being that transparent. Because some people were telegraphing the next wave of rises there was a degree of moral hazard, people taking risky bets knowing what was coming next, and I think the Fed has remembered that.’
Speed of change
Lee shared the view that the rise is likely to be at the level of around 25 bps – raised by fellow bond managers such as DoubleLine Capital’s Philip Barach – but said it was not unrealistic that the first of the gradual moves could be slightly higher.
‘I think it is completely possible they could go to a 50 bps rise when they do decide to rise. However, it is completely dependent on the data and that is not set in stone.
‘I will be very surprised if there is not a more gradual pace to the hikes. One thing people have overlooked is the Fed being able to go back, if the data changes, then they could cut back again. If they have to take it back, they will.’
The Lord Abbett Short Duration Income fund, which was one of the three initially passported into European markets last spring, currently has 29.3% exposure to investment grade corporates, up 2.8 percentage points from the end of 2014.
On a credit quality basis, AAA-rated bonds account for 22% of the fund, compared to a 1% weighting in the fund’s index, while BBB-rated make up 33.9% of the portfolio at present.
The Lord Abbett Short Duration Income; A fund has returned 8.68% in the three years to the end of March 2015. This is while its Citywire-assigned benchmark, the BofA Merrill Lynch U.S. Corporates 1-3 Years TR, rose 6.5%.