Navigating Global Bonds: How Risks and Allocations Have Changed

How do you approach risk in your global bond fund?

 (00:10):

We manage risk in the Global Bond Fund on two different, um, axes. We look at both absolute risk and we look at risk relative to our benchmark, which is the Bloomberg Global Aggregate. That's an investment grade global index that has the majority of liquid investment grade bonds, um, that are investible from around the world. We think about risk in terms of its underlying factors. So we focus on credit quality and credit opportunity. We focus on yield curve and duration, it's the second factor, and we focus on currency risk. Of the three, historically, credit excess return income has been our strongest and most reliable performer, but it carries absolute, not just relative risk. When you're lending to companies and to some governments, you run the risk of the loss of principle. So we're, uh, quite diversified, and at the moment we're relatively cautious. Only about 4% of the fund is actually in high yield names, and most of that is in sovereign currency ideas.

The second factor, currency, is probably the most volatile driver of returns. And in a 20-year average US dollar bull market, I mean, the dollar's been strong more often than weak for the last two decades. It really hasn't been in American investors' friends, but we suspect that may be changing. When we look at the landscape, we've noticed that number one, almost all the US growth is organized around a single theme or idea, AI investment. We noticed that the US Treasury at full employment and relatively strong growth is still running a deficit of 6% of GDP. The debt stock is 100% of GDP. We spend 3% of GDP just on debt service. When we look at fiscal forwards, the futures of policy, we see interest expense, we see defense, and we see demographics all driving spending higher. So we think that leaves the markets vulnerable.

In what ways do you think the Loomis Sayles Global Bond Fund is different to other global core fixed income funds?

(02:17):

When I think about the Loomis Sayles Global Bond Fund and its current context right now, uh, one of the things I'm struck by is how many other global managers have kind of given up on multicurrency benchmarks and have gone to dollar hedged benchmarks. Uh, that has made a kind of investment sense for the past 20 years because the dollar's been strong. But if we're in a world where the regime is changing, um, and the dollar has had a weak summer, that may not be the right answer going forward. So one of our differentiators is our benchmark itself. Over 58% of this fund is in non-dollar securities.

I think the second differentiator I would point to is that we use credit very tactically. We expand and contract, um, our credit exposures depending on the horizon returns that they present, which means that when credit spreads are tight, we use less. When credit spreads are wide, that's usually in periods of uncertainty, we use more. And we feel comfortable doing that because the team has worked together for more than 20 years and we can rely upon the deep credit bench, uh, that, uh, Loomis Sales has had, uh, for, really for its entire existence.

What role do you think a core bond portfolio should play as part of a client’s over overall portfolio?

(03:27):

The Global Bond Fund has an effective yield that is in the 5% range now. So that then, uh, raises the question of will global fixed income hedge an equity event? Uh, and some people have become concerned that it didn't in 2022. That's because that was an inflation shock and a massive rise in interest rates. If the biggest risk in the world is a growth disappointment, that's a deflationary shock, in which case bonds will hedge quite well, but foreign bonds may be a better hedge than US bond. As I mentioned, our deficit is 6% now. In a recession, it might be 10%. What happens if foreign investors go on a buyer's strike? Well, the Federal Reserve is always there, but massive quantitative ease to drive down yields we think would crater the dollar.

If the dollar experiences a policy and cycle driven bear market, its downside could be between 25%, which just gets us back to 2005 levels and 40% if things go really wrong and people lose confidence, um, in the policymakers. You want to have non-dollar currency exposures as part of your total portfolio in such a world, and given that the world is unpredictable, I think you want to have them now.

Loomis Sayles’ global allocation strategy celebrates its 30th anniversary this year. What are the main ways asset allocation has changed over that time?

(05:02):

Asset allocation over 30 years, well, we've seen lots of different things. Emerging market debt has gone from first to worst a couple of times and then come back. We went through quite a long period where interest rates in Europe and Japan were negative, and I would've never predicted that before it happened. So we've seen lots of changes over the 30 years. What I would say has not changed is the discipline and consistency of the Loomis Sayles, uh, fixed income investment process.