CHAIRMAN’S LETTER 2022
In my experience as Chairman for many years of this company, it is clear that successful bond fund management involves sticking to the areas in which one is expert and ignoring the noise of ill-informed public discourse in traditional and social media. The advantages of sticking to expertise are obvious. Ignoring noise (essentially, ignoring the ‘momentum trade’) is less so. This can mean going against conventional wisdom and, in some cases, doing things that appear counter-intuitive. An example – the ‘noise narrative’ in early summer 2021 was that raging inflation would slay the bond markets. Inflation was certainly a factor that we had to take into account in our decision making. That said, the obvious hedge for the prospect of raging inflation – to go wholesale into index-linked and inflation-linked notes in early summer 2021 – would have seen a big loss of value in our portfolios. We considered it- but resisted and prospered. The positions we hold are not broad market bets, but targeted positions based on the strengths of each issuer and the covenant protections underlying each bond.
The performance of the funds that NKAML manages has been pleasing, and we are happy to see that we have beaten our (testing) benchmarks in each of our active portfolios. We have (yet again) beaten the returns of the market’s bellwether – the PIMCO Total Return Fund. Our clients have seen extremely good income yield returns throughout the year from the portfolios managed by us. We anticipate a good year in 2022.
Our thoughts for 2022:
Avoid Chinese bonds – investing in Chinese bonds has always been a risk, given the sometimes opaque accounting standards and the constant threat of Chinese Government intervention. We saw the impact of both these factors on Chinese bonds during 2021. Although never high, we cut our exposure to Chinese bonds virtually to zero soon after the first murmurings of the China Evergrande situation. We expect to keep clear of Chinese bonds in 2022. The same is likely to be the case for Turkish bonds. Having said that, as is usually the case, markets can become significantly oversold. In such a situation we will be ready to act.
Spreads provide opportunity – As one of the main drivers of our portfolio returns, we spend our lives watching spreads. The usual tightening and widening of credit spreads during the course of the year presents the opportunity that we seek, as active managers. Opportunities almost always come and we are watching for them. Favourable moments may present themselves in dislocations between similar credits or along curves. As bond geeks, these are the trades we love best.
Primary markets will remain strong – though issuance was marginally down in 2021 as against 2020, we still see the primary bond markets as being strong in 2022. This is also good news for the secondary market, where we do most of our hunting.
Avoid Sovereign bonds – they are so often priced to perfection. We cannot see that the risk-weighted returns on Sovereign bonds make them an attractive area in which to be in 2022. We believe the credit market will continue as the place to be rather than the Sovereign arena. With low yields and high volatilities, Treasuries are not a sector for us.
Inflation is a fact of life – inflation will be with us for the rest of 2022 and into 2023, when it may start to tail off. Well managed bond portfolios can handle periods of inflation.
Rates rises – these are inevitable but are largely priced into the bond market.
Steepening yield curves – our comparatively shorter dated portfolios defend against this risk.
Global growth rates to continue to rise – the outlook is good for positive growth rates as economies normalise after the pandemic.
Corporate defaults - are running a 20 year lows.
Financials - There is no reason to change our view on financials, which in most cases occupy a substantial portion of portfolios we manage. The regulatory environment favours this risk. Moreover, it favours subordinated financials. Much of the talk of inflation overlooks that it is a positive for banks. Rising interest rates improves profitability through greater net interest margins. We see little on the horizon to change our overweight view of financials.
It will be important this year for us to continue to manage our portfolios actively, positioning funds on appropriate parts of the yield curve. Also, as we have done in the past, we are ready to purchase inflation-linked bonds, if needed, if we see inflation steaming upward. Sectorial and geographical areas also need significant consideration for our bond portfolios. Liquidity and flexibility will remain vitally important. With a proven combination of investment grade and high-yield in bonds we believe our portfolios give a medium to low risk outcome with attractive return outlooks.
With all best wishes as ever
Alastair King Chairman