Last year saw Eigen become increasingly pessimistic about the outlook for his asset class, causing him to hike cash weighting in his JPM Investments Income Opportunity funds to around 70 per cent at one point and sell down positions that had already done well.
In August, the manager told FE Trustnet that investors should start to prepare themselves for a drawn-out bear market in traditional fixed income assets, as government bonds cannot be expected to go through another year as strong as the one they’ve just had.
His pessimistic outlook was reiterated in December, when he warned that the bond market faces “devastation” in 2015 when the Federal Reserve starts to lift interest rates, adding that he was the most nervous he’s ever been in his 24-year career managing fixed income.
Government bonds had a strong 2014, as the graph below shows, surprising many investors who went into the year expecting it to herald the end of the three-decade-long bull market in fixed income. The yield on 10-year US treasuries started the year at around 2.9 per cent but ended it around the 2.2 per cent mark.
Performance of indices in 2014
Source: FE Analytics
In his first update of 2015, Eigen says a lot of “very, very strange things” were going on in the bond market in 2014 which meant sovereign bond yields trended down in developed market regardless of how healthy or not the underlying economies looked.
“Last year was kind of fascinating from my perspective because it was a year where economic fundamentals and things that typically impact fixed income markets just didn’t. Right now technicals are dominating markets, central banks are dominating markets and that’s what’s driving pretty much everything,” he said.
“The mantra now seems to be whatever the lowest developed market rate is that’s available anywhere, regardless of economic fundamentals, regardless of if that economy is in deflation and recession, all developed markets yields need to go to meet that yield.”
The manager gives the examples of the US and Germany. German 10-year bunds are currently yielding just 0.46 per cent, reflecting its softer economic numbers over 2014 and the fact the eurozone economy shows continued weakness and has entered deflation.
The US, in contrast, recently posted data showing GDP is growing at an annualised rate of 5 per cent while other indicators such as unemployment have surprised investors with their strength. Despite this, Eigen expects US bond yields to fall further in the short term as investors flock to this part of the market.
“I guess I can understand that but it doesn’t mean I want to bet on it. It’s not a safe bet with rates this low. But I’m not calling rates are going to rise either - it’s an area I don’t want to play,” he said.
“For me, the global rates markets are broken right now because they don’t respond to traditional factors anymore. When you have broken markets and you’re running a fund that has cash as a benchmark … it’s best to just stay away and just be opportunistic.”
Eigen points to the yield on the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index as illustrating how distorted the market has become and why investors in traditional long-only bond strategies should be cautious.
At around 1.19 per cent, the yield on the index - which covers the majority of government bonds - is less than half of what it was at the peak of the financial crisis and “much less” than where it stood even during the Great Depression.
“The scary thing when you look at that is: where is all the money in fixed income going right now? It’s going into traditional fixed income funds that are making that bet all the time that the rate is going to go even lower [and] closer to zero,” the manager explained.
“I don’t know why people are praying that globally rates go to zero because once they go to zero do you know what the opportunity set in traditional fixed income is? Zero. You’re guaranteed to lose money. It’s really going to pay to have the ability to short, to have the ability to put on relative value trades, to have the ability to hold liquidity and not just be long-only.”
This is “not a healthy scenario”, which is why the $8.2bn JPM Investments Income Opportunity fund has not been attempting to play government bond rate movements, which the manager describes as being a “coin-flip trade” at the moment.
He added: “If you’re betting on rates [in the US] and you’re betting on, for instance, German 10-years to go from 45 basis points the rest of the way to zero, basic math dictates that you’re not going to have returns like you had in the past.”
“That Global Sovereign Plus index which represents pretty much every market around the globe, is yielding just over 1 per cent. If that goes to zero ... you’ve got about 5 to 6 per cent of return left and then you’re guaranteed to lose money. I just don’t understand investors’ behaviour right now - why are they piling into that hand over fist?”
Eigen compared government bonds at current valuations to a stock that is priced at $99. However, this hypothetical stock can never rise above $100 and when it gets there has a zero dividend yield and unlimited downside.
“Who would buy that?” he asked. “I think the answer is nobody but everybody [in the bond market] is buying that.”
However, Eigen has been putting cash to work in recent weeks, saying the turbulence that was thrown up in December by the unexpected decline in the oil price created the fund’s “first exploitable volatility episode” of 2014.
Positions in the high-yield space, especially those linked to the battered energy sector, and emerging market debt - including the first ever holdings in Venezuelan debt - were started in December, bringing JPM Investments Income Opportunity’s cash down towards 45 per cent.
“If you make something cheap enough for us and the price doesn’t make sense, we’ll bring it in. That’s exactly what we did in December,” the manager said.
JPM Investments Income Opportunity is a flexible bond fund that sits in the absolute return space. It prioritises capital preservation, using a risk management and process-driven approach.
FE Analytics shows the offshore fund put in fourth quartile returns over 2014, falling 0.58 per cent as its high cash weighting meant it missed out on many of the gains seen in the government bond and higher rated corporate debt parts of the market. In 2013 and 2012, the fund was in its sector’s second quartile.
Performance of fund vs sector since launch
Source: FE Analytics
The fund was recently chosen by Schroders’ Marcus Brookes, an FE Alpha Manager, as his pick for 2015. Brookes likes the fund because of its track record in protecting investors during times of bond market difficulty.
“Bonds were badly hit during the ‘credit crunch’ leading to them being oversold and very cheap. Bill and his team did an excellent job at investing in these bonds and made good returns for investors in the fund,” the multi-manager said.
JPM Investments Income Opportunity has an OCF of 1.2 per cent.