Newton's approach to absolute-return bond investing
Newton Capital Management
August 2011
Why take an absolute-return approach to bond investing?
Bond markets are driven by investors' expectations about interest rates and inflation. As these expectations change, so do bond yields. Throughout much of the past two decades, low inflation and steady economic growth have allowed bond markets to be relatively stable. However, the global credit crisis changed the background for fixed-income investors radically: short-term interest rates were cut to unprecedented lows and government debt levels rose to historic highs. In the aftermath of the economic downturn, a rise in interest rates (which may be required as part of an eff ort to combat infl ation) could create a 'bear' market in bonds. As most investors hold bonds for their scope to protect capital and income, bear markets in bonds can be especially painful (and usually unexpected). There are two ways in which bond investors may lose capital: through default and via rising interest rates. During the global credit crisis, investors experienced some of the former; as the recovery struggles to take hold, they may be vulnerable to more of the latter.
No need for complicated derivative transactions
There are several ways in which investors may limit capital losses in an environment of rising interest rates. For example, if interest-rate expectations are mounting, use of derivatives to off set the risk of higher rates should be beneficial. Such a strategy need not be complicated and need not cover an entire investment portfolio; buying put options on government bonds, for instance, can be an effective way to generate positive returns from falling bond prices. Alternatively, adding holdings of high-yield corporate bonds may allow investors to benefit from an asset class that tends to do well during times of strong economic growth. Whichever approach investors take in seeking to limit capital losses, their priority should be to keep their strategy simple and liquid in order to provide adequate protection of capital in the event that markets become unstable.
We believe our global thematic approach is ideally suited to absolute-return investing. It has helped us to achieve strong risk-adjusted returns during the recent volatile past:
* Inception: 01 April 2006
Source: Newton, as at 30 June 2011. All data shown is in sterling. Past performance is not a guide to future returns: please see important information at the end of this document. For index explanations, please see important information at the end of this email.
For illustrative purposes, we show the returns from the UK sterling-based strategy, which we have run since 1 April 2006. Although the strategy is managed similarly (whatever its base currency), it should be noted that the performance returns achieved by a strategy managed in a non-sterling base currency may differ in future from the returns of the sterling-based strategy. In particular, interest rate differentials between the major currency regions may lead to variations in respective target returns in diff erent base-currency portfolios.
Our global investment themes are long-term in nature and the forces to which they refer tend to have a significant effect on interest rates and currencies. Using themes to identify areas of opportunity and risk gives Newton an advantage over other investment managers, who may be caught up in the short-term 'noise' that affects markets. Current themes include global realignment and deleverage, both of which have encouraged our bias to currencies other than the euro, the yen and the US dollar. We favour, for example, the Australian dollar, the Swedish kroner and some Asian currencies, which are not tarnished by excessive debt and which enjoy strong economic support.
Summary
In our opinion, an absolute-return approach that relies upon investment manager skill and which harnesses a broad range of opportunities should be clear and comprehensible, and have the potential to achieve attractive long-term returns. Newton Global Dynamic Bond is a dynamic, absolute-return strategy which may invest opportunistically in government bonds, emerging-market sovereign debt, and investmentgrade and high-yield corporate instruments. It may also hold currencies and derivatives to generate additional returns and control risk. Given the prevailing (ultra-low) interest-rate backdrop, there is a threat that central banks have been too slow to remove their stimulus, and that inflation expectations will rise. Traditional bond funds would be vulnerable to higher rates and to expectations of higher inflation, but a diversified fixed-income portfolio, with some downside protection, should still be able to make a positive return, even in a rising interest-rate environment.
Newton Global Dynamic Bond Composite contains fully discretionary portfolios whose objective is to maximise the total return from income and capital growth from a globally diversified portfolio of predominantly higher yielding corporate and government fixed interest securities, and for comparison purposes is measured against LIBOR 1 Month +2% per anumm from 1st December 2009, prior to this it was measured against a custom index which comprises 25% JPM Global Govt Bond (Hedged UK£), 25% ML Global Broad Corp. (Hedged UK£), 25% ML High Yield Constrained (Hedged UK£), 25% ML Global Emerging Sovereigns (Hedged UK£). Returns include the effect of foreign currency exchange rates.
Newton has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®).
Newton, the firm, includes all the assets managed by Newton Investment Management Limited, Newton Capital Management Limited, Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited which are investment management firms and wholly owned subsidiaries of The Bank of New York Mellon Corporation.
Newton Investment Management Limited is authorized and regulated by the Financial Services Authority in the conduct of investment business. Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited (Newton) are authorized and regulated by the Jersey Financial Services Commission in the conduct of investment business. Newton Capital Management Limited is registered with the U.S. Securities and Exchange Commission as an investment advisor under the Investment Adviser's Act 1940. The firm maintains a complete list and description of composites, which is available upon request.
Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Non-fee-paying accounts are not included in this composite. Capital gains, dividend and interest received may be subject to withholding taxes imposed by the country of origin and such taxes may not be recoverable. The custom benchmark comprises JP Morgan & Merrill Lynch indices which are calculated gross of withholding taxes. Past performance is not indicative of future results.
The Pound Sterling is the currency used to express performance. Further information regarding the exchange rates used is available upon request. Returns are presented gross of management fees and include the reinvestment of all income. Actual returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. The fee schedule appropriate for this presentation starts at 0.10% per annum subject to a minimum of £100,000, however, individual fees are negotiated on an account by account basis.
The Newton Global Dynamic Bond Composite was created 4Q06.
Newton has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS ®). For each of the years from 1996 to 2009, Newton has been independently verified by PS Ashland (1996 to 2003) and PricewaterhouseCoopers LLP (2004 to 2009). Copies of the verification reports are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request.
Index explanations
JPM Global Government Bond Index. The GBI Global index is J.P. Morgan's flagship index for fixed rate government debt. The index measures the total return from investing in 13 developed government bond markets—Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan, Netherlands, Spain, Sweden, UK, and U.S. The index is market capitalization weighted and bonds enter and leave at the monthly rebalance. There are no size criteria for inclusion, but bonds must have a minimum remaining maturity of one year.
ML Global Broad Corporate Index. The BofA Merrill Lynch Global Corporate Index tracks the performance of investment grade corporate debt publicly issued in the major domestic and eurobond markets. Qualifying securities must have an investment grade rating. For Canadian dollar securities only, Fitch is replaced by DBRS in the rating calculation. In addition, qualifying securities must have an investment grade rated country of risk. Qualifying currencies and their respective minimum size requirements (in local currency terms) are: AUD 100 million; CAD 100 million; EUR 250 million; JPY 20 billion; GBP 100 million; and USD 250 million. Qualifying securities must have at least one year remaining term to final maturity and a fixed coupon schedule. Original issue zero coupon, 'global' securities (debt issued simultaneously in the eurobond and domestic bond markets), 144a securities, pay-in-kind securities and toggle notes qualify for inclusion in the Index. Callable perpetual securities qualify provided they are at least one year from the first call date. Fixed-to floating rate securities also qualify provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. Taxable and tax-exempt U.S. municipal, U.S. DRD-eligible, euro legacy currency and defaulted securities are excluded from the Index.
ML High Yield Constrained Index. The BofA Merrill Lynch Global High Yield Constrained Index contains all securities in The BofA Merrill Lynch Global High Yield Index but caps issuer exposure at 2%. Index constituents are capitalization-weighted, based on their current amount outstanding, provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face values of bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis. In the event there are fewer than 50 issuers in the Index, each is equally weighted and the face values of their respective bonds are increased or decreased on a pro-rata basis.
ML Global Emerging Sovereigns Index. The BofA Merrill Lynch Global Emerging Markets Sovereign Plus Index tracks the performance of USD and EUR denominated emerging market and cross-over sovereign debt publicly issued in the eurobond, euro domestic or U.S. domestic markets. Qualifying countries must have a BBB1 or lower foreign currency long-term sovereign debt rating. Countries that are not rated, or that are rated 'D' or 'SD' by one or several rating agencies qualify for inclusion in the index but individual nonperforming securities are removed. Qualifying securities must have at least one year remaining term to final maturity, a fixed, floating or fixed-to-floating rate coupon and a minimum amount outstanding of USD 250 million or EUR 250 million. Local currency and euro legacy currency debt is excluded from the Index.
MSCI World NDR Index. The MSCI World Index is a free-float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. As of June 2007 the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States. NDR means that net dividends are reinvested.
1- month LIBOR. LIBOR is the interest rate that banks charge each other for one-month, three-month, six-month and one-year loans. LIBOR is an acronym for London InterBank Offered Rate. This rate is that which is charged by London banks, and is then published and used as the benchmark for bank rates all over the world. LIBOR is compiled by the British Bankers Association (BBA), and is published 11am each day in conjunction with Reuters. It is comprised from a panel of banks representing countries in each currency.
Important information
This is a financial promotion and is not intended as investment advice. Past performance is not a guide to future performance. The value of your investment may go down as well as up. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. No warranty is given as to the accuracy or completeness of this information and no liability is accepted for errors or omissions in such information. Performance is stated gross and net of fees or net of fees only. The impact of management fees can be material. Generally, investment management fees are charged based upon the size of the portfolio, computed quarterly. Please contact Newton for further information.
Newton has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®). For each of the years from 1996 to 2007, Newton has been verifi ed by an independent verifier. Copies of the verification reports are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results and a complete list and description of Composites is also available by contacting Jon Ritz +1 412 234 3781. Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Non-fee-paying accounts are not included in this Composite. Capital gains, dividend and interest received may be subject to withholding tax imposed by the country of origin and such taxes may not be recoverable.
If part of the portfolio is invested in sub-investment grade bonds, which typically have a low credit rating and carry a high degree of default risk, then please be aware that this can affect the capital value of your investment. The information contained within this document should not be construed as a recommendation to buy or sell a security. It should not be assumed that a security has been—or will be—profitable. There is no assurance that a security will remain in the portfolio.
All information relating to Newton and the Newton Global Dynamic Bond Strategy has been prepared by Newton Investment Management Limited. Any views and opinions contained in this document are those of Newton Investment Management Limited at the time of going to print and are not intended to be construed as investment advice. BNY Mellon Asset Management Limited and its affiliates are not responsible for any subsequent investment advice given based on the information supplied.
'Newton' refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Capital Management Limited, Newton Capital Management LLC, Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited. NCM LLC personnel are supervised persons of NCM Ltd and NCM LLC does not provide investment advice, all of which is conducted by NCM Ltd. Except for Newton Capital Management LLC and Newton Capital Management Limited, none of the other Newton companies off er services in the U.S.
The opinions expressed in this presentation are those of Newton and should not be construed as investment advice. Past performance is not a guide to future performance. The value of your investment may go down as well as up.
In the U.S. this document is issued by Newton Capital Management Limited. Newton Capital Management Limited is an investment management firm authorized and regulated in the United Kingdom by the Financial Services Authority in the conduct of investment business and is wholly owned subsidiary of the Bank of New York Mellon Corporation. Registered in England no: 2675952. Newton Capital Management Limited is registered in the United States as an investment adviser under the Investment Advisers Act of 1940. Newton Capital Management LLC provides marketing services in the U.S. for Newton Capital management Limited. Tel: (212) 922 7331
www.newtoncapitalmanagement.com
In the UK, this document is issued by Newton Investment Management Limited, the Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No.13719773. Newton Investment Management is authorised and regulated by the Financial Services Authority. In the UK the opinions expressed in this article are those of Newton Investment Management and should not be construed as investment advice. This is a financial promotion and is not intended as investment advice.
In Jersey, this document is issued by Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited both of Liberte House, 19-23 La Motte Street, St Helier, Jersey, C.I. JE2 4SY. Both companies are regulated by the Jersey Financial Services Commission.
