Rate capitulation continues

2 July 2019

Ani Deshmukh

RAM Active Investments RAM (Lux) Tactical Funds II - Asia Bond Total Return

In continuation of the theme seen since March, June saw a continued compression in global risk-free rate as Central Banks globally continued to emphasize their dovish tilt in response to trade and tariff uncertainties as well as weakening economic sentiment. US 10-year yield ended the month at 2.01%, lower by 6bps, while Bunds saw a more pronounced decline of 12bps, ending the month at -0.32%.  The US Dollar weakened modestly by about 1% in the month, evidencing the declining US rates environment, but was supported given similar yield curve moves in DM as well as EM (see chart below). The G20 meetings resulted in a modestly positive outcome as the US and China agreed to defer further tariffs and restarted a dialogue on tariffs, but a lack of detail on the way forward has made it difficult to gauge the likely path and timelines for these discussions. Risk markets, especially in credit, were buoyed by the declining rates environment and saw IG spreads tighten by about 7bps, while High Yield spreads tightened by about 14bps in June. The macro-economic nature of this risk move was seen in other asset classes as well, with Asian equities up 5%+ in June, largely led by China. Commodities lagged the rally, with metals seeing a +1% return  in the month, as the sector struggled to balance the opposing forces of looser monetary policy and weaker demand outlook.

YTD yield moves globally

Outlook and positioning

Looking back from the mid-year point, 2019 credit markets have largely been supported by the significant move tighter in risk-free rates (10yr UST 70bps, 10year bunds -45bps, 10yr JGBs -11bps) and the resultant expectation of an asset reflation as well as hunt for yield driving equity and credit markets globally. Fundamentals have weakened in contrast, with weaker exports, lower PMIs and sluggish inflation being reported by all major economies globally. Geo-politics and trade skirmishes also remain top of mind, as the investing world increasingly relies on government and central bank support to support asset valuations and hopefully kick-start growth in 2HFY19. In our view, tangible evidence of an easing in tariff wars as well of lower rates translating into stronger economic activity are needed to support riskier asset classes such as equities, given current valuations. The credit space is better positioned, especially in the IG space, as a dovish rate outlook will continue to support better quality assets. High yield valuations have started looking stretched in pockets, as the hunt for yield results in lower-rated bonds getting bid up, and in our mind the risk-reward associated with this segment is unappealing currently. Within Asia, onshore liquidity in China and India remains a key area to watch – we expect the tight liquidity conditions for lower quality borrowers to sustain while segment leaders will benefit. Global rates are the other important driver for credit for 2H –in our view while the easing bias remains, the Fed is likely to undershoot market expectations which are pricing in 50-75bps of rates cuts this year unless their domestic economy weakens materially. However, credit overall remains well positioned as a carry product from here on.

The ABTRF fund returns were 1.64% for June, bringing YTD returns to 7.3%. The fund benefitted from being overweight duration in June (4.7years versus 4.5 years in the JACI) as well as credit allocation (35% China exposure versus 51% in the index) which resulted in a more diversified profile for the fund. As 10yr yields breach 2%, we would look to lower our overweight duration stance modestly, as the bulk of the rates move appears to have been done. That said, Asia (and EM) credit remains a lower-beta space to invest as we look into 2HFY19, as opposed to growth-sensitive equities. The fund would remain weighted towards Investment Grade (73% as at end-June) and maintain a diversified profile as we rotate risk within the Asia and MENA space.

Nexus Investment Advisors Limited, subject to the supervision of the Securities and Futures Commission (SFC) in Hong Kong, has been appointed by the fund's management company as investment manager to RAM (Lux) Tactical Funds II - Asia Bond Total Return Fund.

*Sources : Nexus Investment Advisors Limited