- Fixed income spread sectors generated mixed excess return results amid a sharp rise in front-end sovereign yields. Markets grappled with intensifying inflation worries, driven by soaring natural gas prices and prolonged supply chain issues.
- U.S. economic growth slowed as the spread of the delta variant and supply shortages weighed on third quarter GDP growth. Consumer sentiment rose slightly, reflecting inflation uncertainty. Headline inflation ticked higher while demand for services fell, particularly reflected in airline prices. Personal income dipped amid a decline in unemployment insurance benefits despite an increase in wages. Non-farm payrolls posted a weak gain, with the strongest details in private sector employment. Signs of labor shortages emerged although weekly claims dropped, and demand for workers increased. Improved inventories and rising mortgage rates supported existing home sales.
- Major central banks shift toward tighter policy to combat rising inflation. The Reserve Bank of New Zealand (RBNZ) hiked rates to 0.5%. The Reserve Bank of Australia (RBA) abandoned its bond-yield target amid an improving domestic outlook. UK rates markets priced in a 15-basis-point hike for November following Bank of England (BOE) Governor Bailey’s remarks about countering inflation pressures. The Bank of Canada (BOC) ended its quantitative easing (QE) program, opening the door to a 2022 hike. Major emerging market (EM) central banks including Russia, Poland, and Brazil also hiked rates.
- Most global sovereign short-end yields rose, driven by hawkish rhetoric from central banks on the back of inflationary pressures. U.S. Treasury yields increased, and the yield curve flattened amid supply chain concerns and rising costs. Australian front end yields surged after the RBA held off buying bonds to defend its yield curve control target. Canadian short-end yields spiked after the BOC announcement of phasing out QE and starting to hike rates earlier. In Europe, UK gilts gained after the UK government cut its planned gilt issuance by more than expected.
- Global credit bonds underperformed duration-equivalent government bonds as spreads modestly widened. High yield generated negative total returns, as U.S. Treasury yields continued to move higher. Agency mortgage-backed securities (MBS) slightly underperformed duration-equivalent Treasuries. The sector held up relatively well despite the big increase in front-end Treasury yields, because tapering has been largely priced into the MBS market.
Performance and attribution
- The Fund’s total returns were negative in October as Strategic Sector, Market Neutral, and Tactical positions all detracted.
- Strategic Sector positions were negative over the month. Emerging markets (EM) came under pressure in October, and EM local debt drove negative performance. EM rates moved higher during the month, driving negative performance. Following the EM local index returning -1.3% over the month, the Fund’s strategic emerging markets exposure was a primary detractor, with exposures to government debt from Korea and Russia detracting notably from performance. Exposure to inflation-linked bonds from developed markets, particularly from the United States, within our Activist Governments theme benefitted performance as breakeven inflation rates widened during the month following data showing persistently higher inflation.
- Market Neutral positions were negative over the month, driven by detractions within credit strategies. Long exposures to government debt from Morocco, Romania, Egypt, and Hungary among other sovereigns detracted from performance as 10yr yields rose across these sovereigns. Latest economic releases reflect decreasing household intentions to make major purchases and waning expectations about the general economic situation. Currency strategies were modestly positive over the month as a short US dollar position benefitted performance, as the dollar fell 0.1% during the month. More broadly across currency markets, the Australian dollar led gains within developed markets as the RBA’s decision not to intervene in the bond market raised expectations of a hawkish shift by the central bank. The New Zealand dollar rallied on positive momentum following the highest CPI rates since 2011.
- Tactical positions detracted from performance in October, largely driven by emerging markets exposures and the account’s duration posture. Exposures to government debt from Ghana, Hungary, and Romania within our EMD Overlay theme detracted as 10yr yields rose across these sovereigns. Exposures to Canada and Norway within our Duration Management theme also detracted from performance as 10yr yields rose across these sovereigns. The Fund’s allocation to bank loans, primarily U.S. industrials, continued to contribute favorably over the month. We believe that bank loans remain an attractive opportunity set given solid fundamentals, positive technical tailwind, and as an income-producing inflation hedge.
Positioning and outlook
- We continue to focus on global assets that we feel still present attractive total return potential in a world of low yields. For example, we have been adding to the Emerging Market Opportunities theme that features a combination of exposures to emerging markets external and local debt.
- Our strategy continues to focus on assets that should perform well in a period of volatile, but sticky inflation and greater uncertainty. The best protected areas in our view include inflation linked bonds, consumer-linked structured credit, and bank loans. We are least favorable on U.S. corporate sectors as current spread levels do not compensate the portfolio for a risk of rising spread volatility.
- Market neutral strategies continue to be an important facet of the Fund as volatility presents relative value opportunities in rates and currency.
- We continue to believe we’ve entered a new macro era of higher and more volatile nominal growth and higher and more persistent inflation, underpinned by forces that are unique to this new business cycle. We also believe the Opportunistic Fixed Income strategy is well positioned to take advantage of opportunities in this type of environment.
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