The British poet Rudyard Kipling famously advised the reader of his poem If to ‘meet with Triumph and Disaster / And treat those two impostors just the same.’
Leaving aside Kipling’s other, more objectionable views of the world, that line will ring true for those investors who have endured both good times and bad. So basically all investors.
Franklin Templeton’s bond guru Michael Hasenstab has seen far more good than bad. His long-term track record as a global bond investor is largely unparalleled. Over 10 years he has more than doubled his benchmark, the Citi WGBI, returning 273.5% versus the index’s 110.6%. On a risk-adjusted basis he is top of his category over both one and five years.
But those five-year numbers do include a period of underperformance, as his bearish stance on US Treasuries and the Japanese yen hurt his performance. They were calls that ultimately came good, from October 2016 onward, resulting in those table-topping one-year figures. Today he is marginally short US duration, heavily short the yen and long select Latin American and Asian emerging markets.
That period taught him a lesson similar to that proposed by Kipling. ‘One of the things I have learned over my career is: don’t get too excited when things are going well, because you are constantly tested in this business, and also don’t get depressed when things are going badly,’ he says.
‘Just try to be steady in both of those environments. That way you take a bit of the emotion out of it and you can focus on being a bit more objective.
‘It also keeps your heart rate down,’ he jokes.
Good times, bad times
Much was made of Hasenstab’s period of underperformance, which saw some $16.1 billion pulled from his flagship Templeton Global Bond fund, but he points out that the fund never actually lost investors’ money.
‘[There’s] no question it was a challenging period,’ he says. ‘The one part that gave us some comfort was that we were not losing money. If we look back at August last year, year-to-date, we were basically zero and the market was up 10%. So we hadn’t lost money. We just hadn’t made money as peers had on the Treasury rally.
‘At no point did we have anything that had blown up. We just weren’t participating in this huge Treasury rally. So it was an easier position to recover from, but there’s no question it tested us.’
It is this very same position that has largely driven returns since, as the Fed delivered on planned rate rises.
‘What paid off was that a lot of people who were judged on very short-term performance had no choice but to throw in the towel and so by the time we got to October  everyone had given up on their interest rate position,’ he says.
‘It was that ability to hold to a fundamental position, even if it was underperforming in the short term, that led to those huge outsized relative performance gains over the long run.’
Today Hasenstab believes the majority of managers are still too exposed to US duration risk, despite the Fed signaling the likelihood of further rate rises and the expected return of inflation.
‘Most of the market place, the index as well as the peer group, has a tremendous amount of duration risk. So any small move in Treasuries, like 100 basis points, and the average bond fund is down close to 10% immediately,’ he says. ‘Our duration is zero. We are slightly negative in the US. What we are positioned for is immunizing the fund, or even making money when rates go higher.’
‘When rates go higher – and we think they absolutely will go higher with the Fed unwinding its balance sheet – a lot of investors have a tremendous amount of interest rate risk both in their bond portfolio and all of their portfolios. We saw in October last year that when rates went higher, it hit equities too.’ His index's duration is 7.7 years and the Morningstar World Bond peer group average is 5.5.
While the Fed’s plan to unwind its $4.5 trillion balance sheet will be a boon to his positioning, Hasenstab warned that the central bank’s withdrawal of quantitative easing is by no means risk-free and is unlikely to be a smooth process.
‘Just go through the math,’ he says. ‘The Fed purchased, without any consideration of price, 25% of the net issuance of the US Treasury. It was a monetary financing of our debt. They are now going to stop doing that…. which means the US Treasury has to find a new $1 trillion worth of buyers. ’
Hasenstab and his team go into more detail on these concerns in a new paper called Global Macro Shifts: The Fed’s Long Unwinding Road, but the essential point is that the process will only be smooth if someone buys what the Fed doesn’t. However, buyers such as the Chinese and the oil states of the Middle East seem to be drying up.
Another area of concern for Hasenstab is Europe, where he now has next to nothing invested after selling out of his position in Ukraine in August. This sale also meant he now holds almost no hard currency emerging market debt in the fund.
Hasenstab believes that the threats to the EU have not disappeared, despite a number of seeming to reject the sort of anti-EU stance taken by the UK in voting for Brexit.
‘The market is very complacent on the risks to the eurozone’s cohesion,’ he says. ‘The market got very excited when [Emmanuel] Macron beat [Marine] Le Pen. It thought, “France didn’t have a Brexit moment, they didn’t have a Trump moment, we will go back to European integration.” Well the reality is that 44% of the country, the largest turnout for her party, voted to turn inward and away from the eurozone. That’s a pretty close call.’
Hasenstab’s decision to sell out of Ukraine and other European positions such as Ireland and Hungary over the past few years – despite then buying into certain Asian and Latin American countries – is one of the reasons why the fund has 34% in cash at the moment.
‘Over the past couple of years, [we have been] selling more than we are buying,’ he says.
He explains that the other reason for all this cash is that ‘a lot of the investments we are making right now to get exposure to negative Treasury risk or short yen, euro or aussie [dollar] don’t take cash.’ Instead, they use currency forwards or interest rate swaps.
Still, Hasenstab is untroubled by his cash allocation. ‘One of the worst mistakes investors, including myself in the past, have made is buying just for the sake of buying because you feel forced to,’ he says. ‘We are not going to buy for the sake of buying. If we don’t see something that’s compelling, we will sit on cash.’
Asking the right questions
He remains constructive on a number of emerging markets, including India, Indonesia, Mexico, Brazil and Argentina. Despite feeling there is little else compelling in the market, he opened up a 2% position in Ghana in April, which fulfils the special situation sleeve of the fund previously occupied by Ireland and Ukraine.
‘The new government that came in, we feel is tackling some of the fiscal regulatory problems head-on and is doing a very good job,’ he says. ‘And the market had not fully appreciated the potential that could be realized with some hard to do but simple changes in fiscal policy. Those, I think, are underway and that should unleash quite a bit of potential.’
Although only accounting for a tiny portion of the fund, it is part of a wider effort to provide returns that are negatively correlated to the broader fixed income market – a stance Hasenstab believes will soon have its day.
‘What has worked in the last 10 years, when you have had a bull market in pretty much everything, probably won’t last forever,’ he says. ‘And it is at the point where everyone starts to feel really good about everything that one should think the most. I do think there are a lot of parts of the market that are feeling very content right now, and that’s the point at which you want to ask the questions.’
Head of investment research, Citywire
It’s very difficult to find an adequate home for this fund. The correlation to both developed and developing world debt are too low to be meaningful.
Realistically, what you are getting is an unconstrained global best ideas portfolio.
Hasenstab’s desire to stray off the beaten path can result in some sensational performance, but equally his anti-consensus views often take a while to come to fruition, which can result in periods of underperformance.
The good news is that he has gotten more decisions right than wrong over his tenure.
Given the interest rate climate that global fixed income is entering, you could argue that it will take a strategy like this one to actually make positive returns.