With increased market volatility and the impact of global political events, Legg Mason's Gary Herbert explains why investors need to watch out for liquidity red flags in many areas of the fixed income market
The way to manage political risk, along with rising US interest rates, explains Brandywine Global's Head of Global Credit, Gary Herbert, is to diversify across emerging markets, investment grade, high yield, and safe haven sovereigns.
"We think it's also important to include derivatives. This gives us the ability to mitigate risk using either credit derivatives or adding more high quality duration in the portfolio when there are periods of risk aversion. By doing this we avoid being a forced seller at bad prices when there is less liquidity in the markets."
Herbert manages the Legg Mason IF Brandywine Global Income Optimiser Fund, an unconstrained strategic bond fund which seeks to provide an attractive income while preserving capital by investing actively across a range of global fixed income sectors.
Four years ago, roughly 80% of the Fund was invested in high yield. Today it's closer to 25%. Currently, high yield in the fund is mostly allocated to US and emerging market issues, where we see the best opportunities, and commodity-oriented: oil and chemicals as well as more export-led companies.
Herbert says: "We tend to think in valuation terms that are based on statistics. Today, we would suggest that high yield is about half a standard deviation overvalued in aggregate - about 50 to 70 basis points. And from our perspective, in aggregate, we don't want to have a large systematic exposure."
The accommodative monetary policy seen in recent years has led to central bank balance sheets expanding, however according to Herbert the central banks are now moving away from this unorthodox monetary policy and back to normal growth drivers like private sector investment and expanding consumption by the household sector.
"This is our perspective. If we are right, it implies that rates are going to move higher and therefore managers should consider opportunities beyond traditional safe haven sovereign bond markets, particularly those with negative yields."
Click here to read more about the Legg Mason IF Brandywine Global Income Optimiser fund and how the manager assembles a diversified portfolio with a global multi-sector approach.
