New thinking required for fixed income – Carmignac’s Galvis

The end of a 30-year period of falling interest rates will require fixed income managers to adopt new strategies says Carmignac global fixed income manager Carlos Andres Galvis.

Speaking at the French fund management house’s quarterly meeting in Paris last week, Galvis said the gradual reduction of liquidity means fixed income investing will in future be driven more by stockpicking than by following central bank policy. Galvis argued that the prospect of rising interest rates was not necessarily bad news for fixed income investing as markets would become more realistically valued, offering greater potential for managers able to identify alpha.

Galvis said: “Higher interest rates with risk premia that have been compressed because of the unconventional policy of high liquidity by central banks. That means a very different environment for investors. So the idea of absolute return is going to be more and more important as we go forward. The good news is that we are entering into markets where the policy from central banks is going to be removed. He also predicted currency plays will offer scope for fixed income managers to generate returns.

“So markets will rely less and less on policy and more on the market. And for investors who are top down value driven, it seems like we are going back to more normal markets in the sense that the expertise of stock picking and alpha generation is going to come back into place because we are going to be in more data dependent and less policy-driven markets.”

“We are still far from the point where equity markets, particularly in Europe and the US, will be hit by higher costs of capital. Real interest rates continue to be very low and when you plot that against US GDP numbers, definitely the costs of capital relative to the return on capital, which is the GDP growth, is very low. So increasing rates is not necessarily bad news. What it does is make capital allocation more efficient.

“Currencies have been trendless over the last three years because of all these different policies pursued by central banks, but are going to come back to play as a provider of alpha, driven by differentiation in central banks’ policy. We also like this idea where there should be some convergence of rates from the periphery of Europe to the centre, on the basis that prospects for Europe will improve, with the reforms that have been implemented and are well advanced, particularly in Italy, Spain and Portugal. Greece is a different situation, with a political component that is driving asset prices, which we prefer to stay away from.

“The main risk for 2014 is the risk of significant slowdown of the Chinese economy poses a risk for the global economy. For the time being I would continue to think the main driver for markets is a good story for the US. As long as the US and Europe continue positively, the emerging market story should remain marginal. But if the Chinese economy surprises on the downside that will feed into the world economy. And that will impact the nascent recovery in the global economy.”