Greater volatility and the withdrawal of monetary stimulus mean investors need to find a fund manager who can react to changing conditions in the fixed income market, according to Nomura’s Dickie Hodges.
Hodges (pictured), manager of the $305m Nomura Global Dynamic Bond fund, said that with higher levels of volatility currently in the fixed income market, investors need to be diversified both geographically and by underlying assets. 
“Volatility in fixed income is almost as great as that which we saw in equities and we need to address this issue and start giving back fixed income returns while [limiting] the surprises on the downside,” he said.
“The way we fund managers have to manage money today has to be different to the way we managed it a decade ago or three years ago,” he said. “The way we look to manage money in three years’ time will be different than today. You have to be flexible.”
“We have low exposure to high yield today, we’re running some of the lowest levels than we’ve had historically,” he added. “We have a small amount of investment-grade credit because of fewer opportunities that warrant investment.”
One of the most recent moves in Nomura Global Dynamic Bond is the addition of around 15-16 per cent in peripheral Europe bonds, such as Portugal, Spain and Italy.
“You have economic growth much better than the UK and much greater [political] stability,” he explained.
“Portugal’s 10-year yields at the start of this year were 74 basis points above UK gilts,” said Hodges. “It’s now 16 basis points below – [they have] outperformed the UK gilt market by 56-57 basis points, a huge outperformance.”
Hodges said there had also been similar moves in both Spanish and Italian government bond yields.
One of the more successful trades recently and part of the fund’s diversified approach to fixed income investing is investment in convertible bonds, with the portfolio having taken a 10 per cent position in Japanese convertible bonds in 2016.
A rebound in the Nikkei saw the fund up by 19 per cent towards the end of 2016 and adding a further 10 per cent in 2017.
“You have to have a strong view on equity markets, you have to understand valuation of convertible bonds and where they are today,” he explained.
Part of the Nomura Global Dynamic Bond fund manager’s global remit has allowed him to invest in other areas that some investors might not usually consider, such as emerging markets.
“Emerging markets are something traditionally UK investors might fear,” he explained.
Hodges said that he was particularly keen on four areas of emerging markets where he had found interesting opportunities: Argentina, Egypt, India and Indonesia.
The manager said Argentina and Egypt had improving credit stories from both capital return and income generation perspectives more recently. Argentina was previously shunned by international investors over defaults although has since rebuilt its reputation in the global markets. Egypt meanwhile has tackled soaring inflation by devaluing its currency and secured backing from the International Monetary Fund.
While some might view emerging markets as higher risk, Hodges said the markets he has invested in have strong fundamentals backing them.
“All these countries have active levels of yield relative to UK or more developed markets,” he added.
One of the key moves for the fund in the past year or so was the exiting of all US high yield exposure in favour of so-called Indian ‘Masala’ bonds: debt issued outside of the country but denominated in local currency.
Hodges said the investment grade debt has a lower default probability than some UK corporate bonds and is often backed by the government, which has a lower debt-to-GDP ratio than many developed markets.
Indeed, as central banks begin to withdraw some of the monetary stimulus enacted since the global financial crisis, further issues remain to be discovered.
The Nomura manager said while the Federal Reserve is likely to raise rates three times in total this year and twice again in 2019, he believes that further hikes are unlikely.
Number of accounts by loan type
Source: Federal Reserve Bank of New York
“I struggle to believe they will go higher than that,” he explained. “The reason I struggle with it going higher is that the US has a high debt backdrop. Last year it was in excess of $15trn greater than 2007.
“Globally the level of debt is greater now that it was in 2007. If you look at US consumer in isolation they have borrowed more money on auto loans and credit cards than at any time in the past five years.
“If interest rates go up too high then I believe the US is not in recession but in default.”
The Nomura manager added: “There is lots of risk still ahead of us. Global central banks have had accommodative policies in place for too long. If they’re illiquid in the future they [will] have to get rates higher before they can cut them again.”
Hodges joined Nomura in 2014 from Legal & General, where he was head of high alpha fixed income had managed the firm’s Dynamic Bond Trust. He now oversees a team of four covering different areas of the fixed income market.
“I think we class this as an all-weather fixed income fund. It has the ability to demonstrate positive capital returns even in an environment where government bond yields are going up and [delivering] negative capital returns,” he said.
“The returns you can generate from the global fixed income are significantly greater than those, in my opinion, available to UK gilt, corporate bond and high yield investors.”
Nomura Global Dynamic Bond underperformed the average IA Global Bonds fund during its first full calendar year in 2016, with a total return of just 6.51 per cent compared with a gain of 16.79 per cent for its average peer.
However, in 2017 it was a top quartile performer generating a 5.95 per cent gain compared with a 2.03 per cent return for the peer group. So far, this year it has also been a top quartile performer with a 0.73 per cent total return compared with a 2.27 per cent loss for the average peer.
Hodges said: “One thing demonstrated in this fund is that we have actively generated positive returns even in environments of rising bond yields and interest rates, not just over the bull market but in the current market.”
Performance of fund since launch
Source: FE Analytics
Since launch at the end of January 2015, the fund has generated a total return of 8.92 per cent compared with a 13.1 per cent gain for the sector average.
Nomura Global Dynamic Bond has yield of 4.87 per cent and an ongoing charges figure (OCF) of 0.86 per cent.