Jim Leaviss: History is repeating itself

Jim Leaviss

It’s an adage in investing that not losing money when conditions are tough is just as important as making profits when the markets are working in your favour.

This is why Jim Leaviss, manager of the M&G (Lux) Global Macro Bond Fund, always placed an emphasis on playing a cautious hand in times of economic distress. ‘I’ve been running this fund since 1999,’ he said. ‘I think one thing we’ve done very well over those decades is position ourselves ready for an economic downturn, in advance of that downturn happening.

‘So, if you look back at the pandemic, we went into that with virtually no credit risk. And we went into the global financial crisis with long duration and lots of Japanese yen.’

For Leaviss, history is repeating itself.

‘We’re positioned for some bad economic news on the horizon - but the good news is that, if that does happen, bond investors should see some decent capital returns.

His base case is that central bank interest rates in the major economies outside of Japan have peaked and should start to decline as soon as a downturn happens. His wariness is increased by how 2023 has turned out – a year when the bond market should, in theory, have steadied and recovered after the pain of 2022. The outlook at the start of the year was for a US slowdown, while China seemed all set to rebound in style after its strict pandemic lockdown.

‘Exactly the reverse has happened’, he said. ‘The US has been pretty much the growth driver for what’s left of global GDP and China has been in the doldrums all year.’

So as the US Federal Reserve fought to keep inflation under control, it kept hiking the Fed Funds rate. Having risen from 0.25% to 4.5% over 2022, the rate now stands at 5.5%.

However, taming inflation also means tamping down economic activity, which is why Leaviss is unconvinced by talk of a soft landing and a ‘Table Mountain*’ scenario, where interest rates stay at these elevated levels for an extended period.

‘Yes, it’s possible we will get a soft landing, but they’re rare. They don’t tend to happen, and I think the argument for this would be if the unemployment rate doesn’t go up.

‘But we are starting to see some weakness in the US labour market - so, I would expect the Fed to be cutting in 2024 and the market, I think, discounts the first rate cut probably around the middle of the year. The same is true for the Bank of England and the ECB. So, by June or July 2024, we should have seen some of the major central banks start to cut interest rates.’

As rates are cut, bond investors should enjoy both capital gains while locked in at today’s decent yields. Leaviss is positioning this outlook at the highest quality end of the spectrum.

‘At the moment, we have about 85% of the fund in government bonds. We have US Treasuries as probably our biggest exposure in the fund and we’ve been adding about half a year’s worth of duration over the course of the recent selloff.’

While the recent inflation numbers in the major economies have been trending downwards, Leaviss is aware that factors, ranging from energy prices in cold winter, to geopolitical tensions and the effects of the El Nino weather system on food costs, could reverse that process. His portfolio also includes some US inflation-linked TIPS bonds.

‘This isn’t because we panic about inflation in any way, but those bonds are pricing in 2.3% US inflation over the foreseeable future and that seems like cheap insurance. So if inflation does make a comeback, people will start buying TIPS in a big way.’

There is also an emerging markets element in the portfolio, with Leaviss encouraged by several factors in a select number of well-run economies. These range from the fundamentals of their demographics and natural resources to the high inflation-adjusted yields on local currency issues on offer there, as well as the way their central banks dealt with inflation sooner and faster than their counterparts in many developed economies.

Credit plays only a minor role in the portfolio right now, via investment grade corporate bonds.

‘We still think these offer decent value, but less than perhaps the investors might want, given they also need to get paid for some default risk acceleration if we head into a downturn,’ Leaviss said.

He hopes the market will move in 2024 to increase the weighting of credit.

‘What I would like is a rapid sharp adjustment that allows me to buy back into credit in a significant and aggressive way, he said. ‘Over time, corporate bonds almost always overcompensate for default risk.

‘That’s what, as a value investing house, we’re looking for.’

*The Table Mountain or Tafelberg in Afrikaans, which overlooks the city of Cape Town in South Africa, is a good illustration of the current situation of interest rates, where the high level is maintained for a long period.

This is a marketing communication. Please refer to the prospectus before making any final investment decisions.

Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.

The fund is exposed to different currencies. Derivatives are used to minimise, but may not always eliminate, the impact of movements in currency exchange rates.

Investing in emerging markets involves a greater risk of loss due to greater political, tax, economic, foreign exchange, liquidity and regulatory risks, among other factors. There may be difficulties in buying, selling, safekeeping or valuing investments in such countries.

The information provided should not be considered a recommendation to purchase or sell any particular security. The views expressed in this document should not be taken as a recommendation, advice or forecast.