Striking the right balance in bonds, as interest rate risk returns

There are degrees of risk in equity markets – a long-established large-cap banking stock is (generally) less volatile than a micro-cap mining play – and there are similar principles in fixed income. 

One way the relative risk of credit assets is reflected is through interest rate duration – how long your cash is tied up before you receive your coupon (annual income payments) and your principal investment amount upon the asset’s maturity. It’s a big talking point right now because interest rates are ratcheting up for the first time in years. Locking in a low rate now by buying a 10, 15 or 30-year bond can make a big difference to your total return. At the same time, shorter duration bonds offer higher returns.

In this interview, multi-asset fund manager Neuberger Berman's Adam Grotzinger details how his team is positioned on duration. Does he prefer floating rate or fixed rate assets? Long duration or short duration? Grotzinger explains how he walks the line between maintaining caution while grabbing opportunities while they’re on offer. He also touches on:

• the dreaded “R” word – Is a recession imminent and what are the factors he uses to gauge this?
• The corporate earnings environment, and
• Why global multi-sector is a good place to be.

Edited transcript

How do you think about interest rate duration?

Adam Grotzinger: Compared to the end of last year, at the start of this year, there was more potential for government bond yields to rise, so you need to be cautious on duration.

In our fund, we came in with the lower ends of our boundaries, with around three years of duration at the portfolio level. The aim here was to be less sensitive to interest rates. As you've seen bond yields rise significantly, and a lot of hawkishness from the Fed priced into the curve in the US, we think it's okay to start gradually buying parts of the market that not only give you a bit of duration but some additional spread margin, which is also attractive.

So, we’ve gone from three years to four-and-a-quarter years of duration at the portfolio level, as we've redeployed into long-duration credit and other areas that have cheapened. The market has already priced in a lot of downside to the Fed’s hawkishness, which means we think there’s good value on offer now.

But it's equally not a time where we want to aggressively extend duration. So, it's a combination of owning securities that have mixed maturity profiles and an average duration that's still moderate in terms of its stance, with the potential to reduce if we see interest rates rally from here.

Outside of interest rates, inflation, and Ukraine, is there anything else keeping you up at night?

Grotzinger: I think the big question on everybody's mind is recession or no recession, right? Markets are grappling with that. It's reflected in the volatility of pricing and the market right now, and in the uncertainty on the economic horizon.

I’m focused less on whether the curve is inverted or not inverted, and more on economic fundamentals, such as the state of play for employment. As we push forward over the quarters of this year, do we start to see a change in employment statistics? Do we start to see more people come back into the workforce? How does that affect wages? Employment's going to be, I think, key to understanding that recessionary question and the inflation questions that are still looming.

Corporate earnings is the other thing I want to watch closely. So, as we go through the next few quarters of this year, what are management teams talking about in terms of their expectations and guidance for future corporate margins? Things like capital expenditure and their communication on employment. Is it easy to find labour? And how's that impacting or not impacting their business? That's the biggest dynamic to watch, alongside the power for the consumer to continue to consume. And how do inflationary dynamics and the employment market really feed into that?

What’s one comment you would make about multi-sector investing in 2022?

Grotzinger: I'd say multi-sector is a good place to be. These markets are really fluid and there’s the ability to exploit that and the relative value opportunities within mandates with a more multisector approach. I’d also say that, in multi-sector, we want to be more flexible this year. This is an environment where I think you can have a strategic position around less duration versus more in certain sectors of the market you like. But you also want to be pretty dynamic in managing those and keeping some dry powder on hand to take advantage of what should be a multitude of volatility events in the year and not just a singular volatility event with suppression for the rest of the year.

So, be mindful of the risk budget, don't run it full, be diversified in your exposures, and be tactical in the management that relative value opportunities present you.

What’s one thing you would highlight, for Australian investors, about the benefits of investing in global debt?

Firstly, it’s timely. Spreads have widened in a lot of these global debt capital markets. And so the yield on offer is attractive versus a domestic fixed interest portfolio for an Australian investor. Even when hedging that back to Australian dollars, it's an attractive accretive income position for local investors.

The other would be a reminder that the global debt capital markets are orders of magnitude larger, more diversified, with a plethora of opportunities versus the local market in Australia, which is a smaller debt market. So, there is the benefit of diversification and a richer opportunity set in going abroad.

Fixed Income

How Neuberger Berman is positioned as volatility rocks global debt markets

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The Neuberger Berman Strategic Income Fund is a flexible, multi-sector fixed income strategy that seeks consistent monthly income by investing across the entire bond market with a focus on exploiting mispriced securities. If you would like first access to Adam's insights click 'FOLLOW' on Adam Grotzinger's profile.