An 8% bond yield and the ‘biggest opportunity’ for years

Please note: Yield to maturity (i.e. the weighted average yield to maturity of the bonds held in the fund) was 7.8% as at 30.06.22. The fund’s distribution yield as at the same date was 4.20%.

Sam Benstead, deputy collectives editor at interactive investor: Hello and welcome to the latest Insider Interview. I am here with Ariel Bezalel, manager of the Jupiter Strategic Bond fund. Ariel, thank you for coming into the studio today.

Ariel Bezalel, manager of the Jupiter Strategic Bond fund: Thank you.

Sam Benstead: So, can you please tell us a little bit about the fund. Where do you invest, what's the yield, and what makes it strategic?

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Ariel Bezalel: So, the fund we launched in 2008, and it's a top-down, bottom-up approach to investing in the world of fixed income, so it really has this very dynamic, flexible approach in terms of where we invest geographically, so we've got positions across emerging markets, as well as developed markets where we are very active across Europe and America. From a top-down perspective, on the back of very intensive macro work, we look to see where the optimal situations are, where we believe interest rates could be set to head down in future months or years, and that's based on big, long-term macro views.

A lot of our views, I would say, we look for them to pan out over 12 to 18 months. And then from a bottom-up perspective, I've got an extensive team of credit analysts, and what we do really is cherry-pick the opportunities across investment grade, high-yield, and even sometimes venturing out into distressed, and what we look for typically are what we call deleveraging credit stories, companies that over time will pay down debt through growing earnings or free cash flow.

Sam Benstead: And the yield on the fund, what does it yield at the moment, and is there a target for what you want to pay shareholders in terms of income?

Ariel Bezalel: Yeah, so we don't target a yield. We'll never put our client's capital at risk to achieve a certain level of income. But today, the yield on the fund is the highest it's been for quite some time, at nearly 8%, in fact. And no doubt we'll touch a lot on this later, but we are seeing some really interesting opportunities across fixed income. The most, the biggest opportunity say, in fact, for quite some time.

Sam Benstead: And why is it so important to invest across the fixed income spectrum rather than just focusing on, say, UK companies or government bonds? Why are there so many exciting things out there at the moment?

Ariel Bezalel: So with the flexibility we have, sometimes there are, from time to time, like now, for example, volatility on the macro horizons. And so with the tools at our disposal, we can use the likes of credit derivatives, we can sometimes also use government bond futures to help manipulate the interest rate exposure, to protect our clients to the downside. So the use of derivatives, the flexibility, allows us to carry our clients' capital really through the economic cycle and hopefully try to protect them from some of the pitfalls out there.

• Watch the other part of this video interview with Ariel Bezalel: why interest rates will fall in 2023 and how we are profiting

Sam Benstead: What is the typical split in the fund, and how are you positioned at the moment in terms of government bonds and corporate bonds?

Ariel Bezalel: So to keep it simple, when we are feeling pretty optimistic about the economic outlook, you'll find a higher allocation to corporate bonds. And within that, we'll have a higher allocation to the likes of high-yield, which tends to do well in a healthy economic environment, in a bullish economic environment. And when we are feeling a bit more cautious, a bit more pessimistic about the outlook, we'll tend to increase our government bond exposure, and to be more specific, it's to higher-quality government bonds where we'll increase our exposure, so to the likes of UK government bonds, US treasuries, etc, where we'll increase our exposure.

In terms of how we are set up today, we are set up pretty cautiously. So we have over 50% of the portfolio in high-quality and typically medium, long-dated government bonds. That's dominated by exposure to the likes of US treasuries and Australian government bonds. And then on the other side, in our credit book, although optically it sounds [like] a lot, we've got about 50% of the portfolio in high-yield.

If you actually look under the bonnet, within that high-yield exposure, it's dominated by short-dated paper, defensive sectors such as telecoms, healthcare, pharmaceuticals, [and] hospital operators, and then we've got within that a number of special situations where we are generating pretty high yields and we see a catalyst for the bonds to perhaps be taken out of a premium in the near term, or we are waiting for some sort of event that could lead to a pop in the bond price. That's how we define some of the special situations we have in the portfolio today.

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Sam Benstead: It's been a tough start to the year for the fund. It's fallen about 10%, and this has come as global stock markets have also fallen. Bonds are meant to be a defence against volatility, against pessimism in markets, so why has the portfolio fallen in tandem with stocks this year?

Ariel Bezalel: Yeah, it's a bit of a misnomer, you could say, in the sense that it depends which bonds you own in terms of how they protect you through certain economic environments. But typically, you are right. If we are in a slowing-down growth picture, and inflation is pretty benign, typically government bonds will do pretty well. Corporate bonds may actually suffer in that environment, especially the likes of high-yield bonds. But the reason the environment this year for bond investors has been very tricky is because we have a high inflation picture and, combined with that, a slowing down in global growth, so that's quite toxic, also commonly known as stagflation.

Coming into this year, our view was that the inflation picture, the inflation outlook, would start to improve, i.e, inflation numbers [would] start to come down Q2, Q3, and we felt that there were a number of signs that the economic picture would start to deteriorate, which would mean that central banks would have to start thinking about cutting rates in the not-too-distant future. We actually believe that's still likely to happen, but that the inflation, the roll-over in inflation, just simply means it's going to be a bit further out.

Now, the reason why the high rates of inflation have caught us offside a bit is because of the Russia-Ukraine war. The Russia-Ukraine war led to another sharp rise in commodity prices, led by the likes of food prices and oil prices and a whole host of other commodities, in fact. But of late, what we are beginning to see is a lot of these commodities are starting to come off quite sharply. So whether it's metals, the oil price is starting to crumble, and even agricultural commodities are also softening up.

And we're also seeing a number of data points from the likes of America and especially from Europe, telling us that growth is becoming more and more challenged. And so we think that at some point later this year, the Fed will have to rethink its hawkish bias and that should trigger a decent rally in government bonds. So you could see a bit of a round trip and the reverse of what we have had a year-to-date in government bonds, in our opinion.

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Sam Benstead: And the fall in bond prices has meant higher yields. You can now get a decent income from bonds finally, [and] you said the fund yields about 8%. So, is now a great time to actually be investing in fixed income?

Ariel Bezalel: The way we think about it today is, if you look at the overall high-yield market and the overall investment grade market, broadly speaking, it's not necessarily pricing in a decent recession yet. However, if you cherry-pick opportunities - and that's what's great about active asset management, that's what we can do is cherry-pick those opportunities across investment grade and high-yield, where we think a decent recession is being priced in, and where you have fairly defensive characteristics in a lot of the businesses we're lending money to - we think that there's pretty good money to be made on a kind of 12 to 18-month view.

So, for example, we are buying triple Bs in real estate companies, in certain healthcare businesses, on spreads of 250 to as much as 400-plus over, I mean that's recession-like valuations. And then high-yield in double Bs and high-quality single Bs where we are secured on assets such as telecom networks, cable networks and even hospitals, and sometimes even gaming companies where we are secured on the business, which also has a bit of a defensive element to it.

You can get high single digit, you know, 6%, 7%, 8%-type yields, the kind of yields we haven't seen in quite some time, in fact. But look, having said all that, what we are doing in the fund is realising that the economic landscape is going to be somewhat challenging for at least the second half of this year, if not as we go into 2023, and so to protect and hedge our clients, that's a big factor as to why we've got a healthy allocation to high-quality sovereigns as well.

Sam Benstead: Ariel, thank you very much for coming into the studio.

Ariel Bezalel: It's been a pleasure, thank you.

Sam Benstead: And that's all we have time for today. You can check out more videos on the interactive investor YouTube channel where you can like, comment and subscribe.