DAILY SKETCH - Our portfolios are well prepared for a possible continuation of the bond markets correction

    • Daily sketch

Yesterday, I wrote that I would not be surprised at all if the correction in global bond markets continued in the following period. Given that we have been expecting this correction for some time, I would like to emphasize in today's text that our bond portfolios are well prepared for this scenario and that they are therefore managed very defensively.

DAILY SKETCH - Our portfolios are well prepared for a possible continuation of the bond markets correction Within the risk management of bond portfolios, interest rate risk management is key. Simply put, during bond corrections, bond prices with longer maturities tend to fall more. Under otherwise the same circumstances, it is true that an increase in the required yields to maturity, say by one percentage point, will cause a much larger decline in the price of a bond with a ten-year maturity than a bond with a two-year maturity, for example.

The key to managing the interest rate risk of the bond portfolio is the so-called duration, which indicates the sensitivity of market prices of bonds to the movement of interest rates, or required yields to maturity respectively. At the same time, it is true that the lower the duration of the portfolio, resp. the shorter the average maturity of the bond portfolio, the lower the interest rate risk is present in the portfolio. For example, for our main bond fund - Conseq Invest Bond Fund - the portfolio duration is only 1.8. In contrast, the duration of the benchmark is significantly higher at 6.6.

This fact leads to the key conclusion that in the rise of the required bond yields to maturity, resp. decline in market bond prices, our fund will suffer much less than the benchmark. After all, we have witnessed this development in recent weeks, when our bond fund significantly exceeded its benchmark. Underweight on duration, of course, will not completely protect our bond portfolios from a decline, however, at least compared to benchmarks, this very defensive setting will mean a very significant relative outperformance of our fund.

And as for corporate bonds, they are also very expensive at the moment, as the so-called credit spreads, or risk premiums, which measure the yield premium on corporate bonds compared to relatively risk-free yields on government bonds or interest rate swaps, are well below historical averages. However, our active management of corporate bond portfolios is also set relatively defensively in terms of credit risk. In the case of corporate bonds with a non-investment speculative rating (high-yield), we focus mainly on companies that are not extremely overindebted, for example as measured by the net debt/EBITDA ratio, and companies that generate very solid cash flow, for example as measured by operating cash flow/net debt ratio. Therefore, I dare to say that our very robust credit analyzes should help prevent a significantly above-average occurrence of problematic issuers.

Michal Stupavský
Investment Strategist at Conseq Investment Management, a.s.


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