A 7% yield from global bonds

Jupiter Strategic Bond manager Harry Richards sits down with ii’s Sam Benstead to discuss his outlook for global bond markets.

He talks about how his “strategic” bond fund is managed, and what yields investors are now receiving from his portfolio.

The conversation includes Richards’ view on the economy, as well as the best and worst-performing investment decisions he's made in 2024.

Jupiter Strategic Bond is one of ii’s Super 60 list of recommended fund ideas.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Harry Richards, manager of Jupiter Strategic Bond Fund. Harry, thanks very much for coming into the studio.

Harry Richards, Jupiter Strategic Bond manager: It's a pleasure. Thank you for having me.

Sam Benstead: Can you give me a quick summary of what the fund does and explain also why it's a strategic bond fund?

Harry Richards: So, Jupiter Strategic Bond is a flexible bond fund. That's what we mean by strategic, is that it has the ability to do a lot of things within fixed income. We can invest in anything with a coupon and a maturity anywhere around the world in any currency, anywhere through the credit-risk spectrum, all the way from high-quality bonds, down to high yield.

And what we try and do, and what that strategic element means to us, is allocating to those different pockets of the market at the right times when valuations in those sub-sectors are the most attractive. And ultimately with the idea or aim of delivering very, very strong risk-adjusted returns for our clients.

Sam Benstead: And does the fund have an income or a capital growth objective? What are you managing money to achieve?

Harry Richards: It is a fixed-income fund, so there will be an income associated or generated by the fund. But it's not something where we have to achieve a certain level of income. We don't have a yield target and it's very, very clear reasons for that. If you do have a yield target, it tends to mean that you chase the market at the wrong times.

So, if you always have to achieve a certain level of yield when the market is expensive, you're reaching for risk at the most expensive point in time. And conversely, you may be under when the market is very cheap, so we don't do that. The yield or the income that we generate is an output of our process and it's really something that we generate as a result of our top-down macro asset allocation.

With regards to capital appreciation, if we're doing our job well, we should be generating some capital return as well for our clients. If we're picking the right bonds in the right sectors, in the right parts of the market at the right time.

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Sam Benstead: We've seen interest rates rise to just under 5% now in the UK. Bonds, their income is linked to this interest rate. So, why is it an attractive time to invest in fixed income today?

Harry Richards: So, if you look at the yields available in the market at the moment, we've got some of the highest levels of yields on government bonds that we've seen in the last 20, 25 years, and that to us is really interesting. Yield is one component, as I previously mentioned, of your return potential.

The other is, of course, capital appreciation. And when you're starting point, there's a higher level of yields, it means that you can potentially create higher returns going forward. And locking that in can be a great idea. So, when we look at the market today, actually investing at a point of higher yields means that actually going forwards, returns should be greater.

Sam Benstead: And what kind of yields are we now talking about on this portfolio?

Harry Richards: The yield on the strategic bond is currently 7.25%, but the distribution yield that gets paid out on a quarterly basis to clients is 5.25%. So, what that shows you is that we're buying some bonds below par, below the level at which they mature at, and you have some capital appreciation baked in.

If we're buying bonds at 99 and they redeem at 100 in one year's time, of course that capital appreciation gets captured in that yield to that worst number that I gave you of 7.25%, but not necessarily in that distribution yield or the ongoing income that's paid out on a periodic basis.

Sam Benstead: So, you have this flexible bond mandate. You can go anywhere in the world looking for fixed-income ideas. So, how do you use that flexibility, what levers do you pull to make the most for investors?

Harry Richards: There's two main levers that most people think of when talking about fixed-income funds. The first is interest-rate sensitivity, or duration is the other word for that. And the second is your exposure to the credit market. So, your spread duration is another measure. So, what's your sensitivity to spreads widening or tightening. And of course, spreads are just a measure of the amount extra you're getting paid to lend to a company over and above the government bond of a similar maturity profile.

And we can also manage things like cyclicality within the portfolio, being more exposed to cyclicals versus non-cyclicals. It's better early on in the cycle and we can also invest within emerging markets as well, which tend to be more risk-on exposures that we can take. As we try and build a portfolio, managing those high-level tools is really important to make sure that the fund exhibits the right characteristics.

So, when it comes to duration or that interest-rate sensitivity, we can have exposure to longer-dated bonds, which might lead to greater capital appreciation if yields fall. And when it comes to credit, when spreads or the extra premium you get over government bonds is elevated relative to history, we might want more exposure to companies lending money to businesses as we may be getting excess premium embedded there.

And to do that, we can increase our absolute exposure that we lend to them. Or we can lend to them for longer, and that can once again increase the capital appreciation that you can bake in beyond the income. So, that gives you a few ideas. But of course, there's a number of things that we can do on top of that, like currencies as well.

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Sam Benstead: And how are you positioned today then, and how does that reflect your view of the world that we currently live in?

Harry Richards: So, at the moment, as we look at the landscape, we think we're pretty late in the investment cycle. Unemployment rates globally are pretty low and they've been rising. And when they start to rise, if you look through history, that tends to be a measure that actually has momentum, i.e. it carries on rising. And a rising unemployment rate, typically, is a great solution for inflation being a little bit too high.

But the problem is, it's not a great solution for growth. And so when interest rates are high, like they are today, that can be a great time to invest in government bonds. And so government bonds to us around developed markets have some of the most interesting return potential of any parts of the market today.

At the moment, we like lending to countries like the United States, Australia, New Zealand, and the UK because we expect yields to fall. And that's just one side of the portfolio, that government bond component.

But if we look to risk assets, things like credit exposure, whether that's investment grade, emerging markets or high yield, those elements of the market with a bit more risk, we're actually pretty cautious. I would love to sit here and say, actually, everything within the asset class is super-attractive, but relative to their own history, credit is really quite expensive.

And so now is the time not to be reaching for yield, not to be doing anything that is too aggressive, and actually trying to deliver defensive income.

I'll give you one example. We look at BB spreads in the US over the last 20 years. Now, BBs are some of the higher-quality parts of the high-yield market. And, of course, the spreads, the extra premium you're getting for lending to those businesses relative to a government bond of a similar maturity, is pretty much the skinniest that it's been over that last 20 years. It's in its first percentile over that time. So, it's been more expensive less than 1% of the time. That is a time where we want to be taking chips off the table. So, we've been decreasing our credit risk, generally speaking. We see some risks to the outlook and we think that the growth picture is a little bit more murky than many others.

So, when we look at our portfolio today, if you combine those two characteristics, what you have is a barbell where we generate a bit of extra income from lending to buying short-dated maturity bonds in the corporate sector. But we have a longer-dated exposure to government bonds, where we see more potential for capital appreciation.

So, at the moment for us, it's credit for income, and government bonds for capital appreciation and income.

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Sam Benstead: Can you talk me through some of your best investment decisions this year? And also some of your worst, some that haven't actually worked out as well as you might have hoped?

Harry Richards: So, one of the things that we've done really quite well this year is manage our credit book. Our exposure to the high-yield market, emerging markets and investment grade has done really well for us this year. We've delivered some really stunning returns and we've maintained that exposure for much of this year.

As we got into the summer months, we started to cut that quite materially. And as you may know from following the markets, high yield has done really well this year, but we've been banking some of those profits as a result of some of the things that I've been saying, that the market is now a bit expensive for us and we've been decreasing our sensitivity to credit-spread widening that may unfold at some point.

Within that, there's a few different pockets that have done particularly well for us, and these were areas that we've built positions up over the last few years. Real estate has done incredibly well for us. Some positions in the portfolio have actually delivered over 100% year to date.

The financials book that we have has done really well. We increased our cocoa exposure, or subordinated financials. That's the riskiest part of the financials or lending to banks within the fixed-income market. And we increased that up to 10%, 10.5% in the latter stages of last year, and they've pretty much without fail delivered close to double-digit returns across the board.

And the final bit within credit that's done well for us has been US healthcare. We've been lending to some of the hospital operators in the United States, and they had some issues due to Covid. They couldn't source enough staff, so they had to buy in or contract a lot of temporary labour and that really hampered their margins. And as Covid started to abate and the labour market started to soften, they've had to do that less.

More people have come back to working in that space and the wages that they charge have also come down. And buying into those businesses on a senior-secured basis, so, we have the hospitals as collateral should anything go wrong, in a similar way to what you do with a mortgage, for example from banks' perspective. These businesses have seen deleveraging come through and generate returns of between 20% and 30% for some of our exposure. So, those are some of the things that have gone well.

In terms of what hasn't gone so well. As things stand today, that longer duration positioning that we've held for this year has been in and out of the money, so to speak. It's been very beneficial during parts of the year, but more damaging in other parts of the year. More recently, with Donald Trump's election in the run-up to that, government bonds haven't performed quite as well. And so we've seen yields move slightly higher within that space.

When we think about what that means going forward, as we were discussing, I actually think that the levels of yield that we see at the moment overcompensate you for the risk embedded in those bonds. And that should be a great future source of return as we look forwards. But as things stand at the moment, that's been a drag on performance this year.

Sam Benstead: Harry, thanks very much for coming into the studio.

Harry Richards: Thanks very much for having me.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can, like, comment and subscribe. See you next time.