Bond fund price movements

Hoenir

Short dated bond yields hit peaks in August 2023 at a time when markets thought the BOE might raise the base rate even higher. Capital prices then rose back up sharply on the back of more stable inflation figures. That's what created the performance blip.  Even now the yield curve remains inverted. 

aroominyork

Hoenir said:

Short dated bond yields hit peaks in August 2023 at a time when markets thought the BOE might raise the base rate even higher. Capital prices then rose back up sharply on the back of more stable inflation figures. That's what created the performance blip.  Even now the yield curve remains inverted.

Nope, I don't buy that 'performance blip' logic. It is not as short dated as genuinely 'short dated' funds, as you can see from how it fell further during Truss/Kwarteng.

Hoenir

Average gain from August through to January is around 16% . Data sourced from DMO.


Data Date: 15-Mar-2024       GILT MARKET

Month                                 Short 

 Aug-2023                         4.51%

 Sep-2023                         4.57%

 Oct-2023                          4.54%

 Nov-2023                          4.23%

 Dec-2023                          3.80%

 Jan-2024                           3.77%

Note:

1.  The historical monthly average gilt yields quoted on this page are simple averages of the close of business redemption yields for each month of the prevailing 5 (short), 10 (medium) and 30 year (long) benchmark gilts. From June 2005, ultra-long yields are reported - these are the simple averages of the close of business yields of the 50-year benchmark gilt.  The DMO regards all gilts with a maturity of over 15 years as long - the distinction between long and ultra-long in this report is simply to distinguish between 30- and 50-year yields.  Before April 1999, the long yields reported are simple averages of the close of business yields on the prevailing 20-year benchmark gilt. 2.  Since 24 July 2017 the daily yields used in these calculations have been derived by the DMO from the Tradeweb FTSE Gilt Closing Prices. Prior to that, the yields were derived from the GEMMA reference prices. 3.  The formulae used by the DMO to calculate these redemption yields appear in the paper "Formulae for Calculating Gilt Prices from Yields", an electronic copy of which is available on this website. 4.  Although the DMO does not publish historical rates from its yield curve model, rates from the Bank of England's model are available. These can be accessed at: www.bankofengland.co.uk/statistics/yield-curves.

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aroominyork

Even sober I have no idea what that is about, Hoenir.

masonic

aroominyork said:

I’m re-posting my question in case anyone want to answer. When you allow for yield/credit quality, defaults and duration/interest rate sensitivity, and a bond fund still significantly outperforms, must that come down to bond selection or could other factors be at play? (This fund has done well for me over the last year and I’m trying to understand whether I am cruisin’ for a bruisin’ or potentially backing a very good fund manager.)

According to Trustnet, the Man GLG fund holds 55% Europe ex-UK sterling bonds, which is significantly higher than the index, and has pretty much eschewed US sterling corporate bonds (I had no idea these existed, but they make up close to 20% of the index). So the geographical spread is different. It has a 50% overweight to BBB and less higher credit quality bonds, so the credit risk is different. It holds over 60% financials (apparently it is bullish about "alternative financials"). Financials make up double that of the index, so the industry sector spread is fairly different. As a result it has a running yield of 7.2% and YTM of 11.1%, both higher than the index. The duration however is quite similar to the index.

But apart from the different geographical allocation, the overweight to financials, the lower credit quality and higher yield... I can't think of anything that could explain the difference in performance

aroominyork

OK, let's unpack this a bit. btw, I assume US sterling corporate bond just means US bonds hedged to Sterling since the fund is 80% Sterling or hedged, just like strategic bond funds need to be 80% Sterling or hedged.

For all the discussion above about short duration, the fund's recent factsheet says modified duration is 6.02 years. If is used to be shorter, it no longer is. I don't see why the credit risk is hugely significant since many actively managed bond are packed full of BBB. The factsheet has a running yield of 8.53% and YTM of 8.64%. 

I don't see anything very left field here. I expect the manager would say he has strong views about certain sectors (eg preferring European to US financials) and uncovers mid-high yielding bonds which are underpriced. Is that fair, and, coming back to my original question, after taking into account duration, yield and defaults, is there anything other than sector/bond selection to account for this (albeit short term) performance? And, if that is the case (this is me trying to understand how bond fund pricing works) is the increase in the fund's price - that part which cannot be explained by yield, by duration when interest rates change, or by low defaults - due to other people realising later than the manager that the bonds he has chosen are good value and hence buying into them, pushing up their price?

masonic

aroominyork said:

OK, let's unpack this a bit. btw, I assume US sterling corporate bond just means US bonds hedged to Sterling since the fund is 80% Sterling or hedged, just like strategic bond funds need to be 80% Sterling or hedged.

The HSBC index fund previously used for comparison tracks the Markit iBoxx GBP Non-Gilts Index, which only includes Sterling-denominated bonds. This is not hedging, it is companies listed on any market in the world borrowing money in GBP through the issuance of bonds.

aroominyork said:

For all the discussion above about short duration, the fund's recent factsheet says modified duration is 6.02 years. If is used to be shorter, it no longer is. I don't see why the credit risk is hugely significant since many actively managed bond are packed full of BBB. The factsheet has a running yield of 8.53% and YTM of 8.64%. 

I don't know why there has been discussion of duration being different either. The fund was launched in September 2021, so it has only been going for 2.5 years and during that time its duration has been close to that of the index/sector. Hence my last comment about duration being similar.

aroominyork said:

I don't see anything very left field here. I expect the manager would say he has strong views about certain sectors (eg preferring European to US financials) and uncovers mid-high yielding bonds which are underpriced. Is that fair, and, coming back to my original question, after taking into account duration, yield and defaults, is there anything other than sector/bond selection to account for this (albeit short term) performance? And, if that is the case (this is me trying to understand how bond fund pricing works) is the increase in the fund's price - that part which cannot be explained by yield, by duration when interest rates change, or by low defaults - due to other people realising later than the manager that the bonds he has chosen are good value and hence buying into them, pushing up their price?

There is only one way the manager could have delivered a 22% annual return at a time of stable interest rates, which is almost triple the fund's yield and quadruple the return of the average fund in the sector. Bond prices have limited upside and never mature above par, so appreciable capital gains come from buying up distressed debt of companies whose credit rating has not yet been downgraded to reflect their current situation in the hope that they recover. The fund can hold up to 20% junk bonds, which would prevent forced sales if some of the debt is downgraded during the holding period. This is analogous to Capital Gearing Trust's side hustle of trading investment trusts based on their discount/premium, which it employed successfully to boost returns for many years. But while established investment trusts are diversified equity vehicles where total loss is extremely unlikely, companies whose debt is trading at bargain basement prices may end up defaulting.

The fund clearly has little in the way of track record, but the manager appears to have done something similar over at Schroder before moving to Man Group. His tenure there resulted in a 20% outperformance of his fund vs sector average over 4.5 years, but it is notable that almost all of the so far accumulated outperformance was wiped out during the Covid crash. It would have been interesting to see what would happen in a crash that was less of a flash in the pan, but the manager hasn't been around long enough to trade through a severe recession.

aroominyork

Thanks, masonic. On the 18th post of this thread we're getting to the nub! Can I please play this back to check I understand.

As an investment grade fund it cannot hold a truckload of high yielding junk bonds, yet its returns are more akin to a high yielding than an IG fund. The fund's yield is a little higher than the sector average, so most of its outperformance comes from capital gain. It does this by buying bonds from companies which have IG status but are considered distressed.

As an example, two bonds each have six years until maturity and pay a 5% coupon. Bond 1 is high quality with minimal chance of default so is priced to return little premium about its coupon and is selling for somewhere between £70 and £75. Bond 2 is from a distressed company and is selling for £40. Jonathan Golan, the Man GLG manager, thinks the bond is less distressed than the market's view and buys it. (If it gets downgraded, the 20% non-IG the fund can hold means it does not necessarily need to be sold.) As Bond 2 gets closer to maturity it reliably pays its coupons and its balance sheet starts looking less distressed, so its price rises and gets closer to the price of Bond 1.The price rise of Bond 2 reflects the capital gain of the Man GLG fund.

Is that broadly what is happening?

masonic

Broadly yes. Exactly what is going on under the hood is difficult to judge, although the manager may have published some commentary on this. Essentially, the result suggests the manager has been fishing in the IG bond market for the debt of companies that have taken a bit of a knock in the hope enough of them will pull through to prevent the fund breaching the 20% junk limit. To some extent it could be through favouring one or more sectors that have been facing difficulties at a particular time. In so doing, over the past 12 months the capital gain achieved has allowed it to generate significantly higher returns than any fund in the Sterling high yield or Sterling strategic bond sector, with the exception of its stablemate Man GLG Dynamic Income run by the same manager, presumably doing the same sort of thing.

Who is to say whether this is a lucky alignment of manager with circumstances or a repeatable strategy.

aroominyork

Thanks. It's pretty much what I suggested in my opening post, with the additional info that he has to fish mostly in the IG pond for distressed bargains. In terms of sector, I've read interviews where he explains why he avoids US banks but sees value in European financials.