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Fixed Income: Unconstrained Fixed Income: Taking the Handcuffs OffVideo

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Description: In a market where finding good opportunities can be difficult, unconstrained fixed income can provide a breakthrough. Irena Alagic, Fixed Income Specialist, discusses why now is the time to pursue this flexible opportunity.

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Transcript: <p><b>JPM – Fixed Income October – Transcript – TIME: 7:03&nbsp;</b></p> <p>[upbeat music]&nbsp;</p> <p><b>Mr. Goldberg:</b> Hi, and welcome to Markets Monthly. I’m Andy Goldberg, your host. I’m from the Client Investment and Strategies Team here at J.P.Morgan. And I’m joined today by Irena Alagic, fixed income strategist. She sits right over there. Irena, thanks so much for being here.&nbsp;</p> <p><b>Ms. Alagic:</b> My pleasure.&nbsp;</p> <p><b>Mr. Goldberg:</b> I know you wanted to talk to us a little bit about this concept of unconstrained fixed income.</p> <p><b>Ms. Alagic:</b> Right.&nbsp;</p> <p><b>Mr. Goldberg:</b> I think the idea is fixed income’s had a great rally. Sometimes our clients think of equities as a little bit expensive, but fixed income’s an even tougher playing field right now. There are pockets of opportunity, but they’re tougher to find. Why don’t you start off though by setting the broad scene with fixed income? Where are we in the fixed income markets? How did we get there? Maybe a little bit about central banks and their role in it first?&nbsp;</p> <p><b>Ms. Alagic:</b> So central banks have been buying assets since the end of the financial crisis to help the global economy stabilize. As you know, that’s worked pretty well actually so, between the Fed, the Bank of Japan and the European Central Bank, they now own jointly around $15 trillion of assets. And the Fed told us just recently that they’re going to start normalizing their balance sheet, but even with that, that number is not likely to go down by much over the next-&nbsp;</p> <p><b>Mr. Goldberg:</b> Well I mean-&nbsp;</p> <p><b>Ms. Alagic:</b> -couple of years.&nbsp;</p> <p><b>Mr. Goldberg:</b> I mean the Fed has gone out of their way to point out that they’re going to do that only very gradually, so the point is they’re still a big player in the bond market-&nbsp;</p> <p><b>Ms. Alagic:</b> Right. Exactly. And what that dynamic has done is it created sort of a crowding out effect among private investors. And engendered this global search for yield that seems insatiable at times. And as a result, it’s gotten trickier and trickier to invest in fixed income. I mean, even if you just look at 2017, a lot of our return expectations for the year have gotten pulled forward. I mean, there’s still opportunities out there, but you have to look far and wide to find these pockets of value, if you will, and that’s why we think unconstrained fixed income investing makes a lot of sense.&nbsp;</p> <p><b>Mr. Goldberg:</b> Great. So let me just play that back to you real quick. Tons of central bank buying bid the price of the assets up so the yields go down and stimulate the economy has worked. The problem is now all those assets are expensive. It’s harder and harder to find good opportunities, so you’re saying enter unconstrained.&nbsp;</p> <p><b>Ms. Alagic:</b> Right, exactly.&nbsp;</p> <p><b>Mr. Goldberg:</b> What is unconstrained?&nbsp;</p> <p><b>Ms. Alagic:</b> Okay, great. So unconstrained funds in fixed income typically are funds&nbsp; that have a lot of flexibility. So, usually they don’t have a benchmark, which means that the fund manager has the freedom to go anywhere and to source their best ideas from across global fixed income markets. Because there’s no benchmark, they don’t have to own just U.S. high yield or just European high grade or munis for example. In addition, they’re not wedded to any specific asset allocation within fixed income.&nbsp;</p> <p>And they can shift it over time as the investment environment changes, so if they foresee a risk on period, they’re going to buy more U.S. high yield. If they foresee a slowdown in the economy, they might buy more core fixed income, so there’s a lot of flexibility built into the structure of unconstrained funds.&nbsp;</p> <p><b>Mr. Goldberg:</b> Okay, so that sounds great and all, you know, flexibility, they can get access to more opportunity, maybe add some diversification, but it also sounds a little uncomfortable to me. I mean if you take the rules out-&nbsp;</p> <p><b>Ms. Alagic:</b> Right.&nbsp;</p> <p><b>Mr. Goldberg:</b> -maybe you can get into trouble. What makes an unconstrained manager good or successful? What are you looking for?&nbsp;</p> <p><b>Ms. Alagic:</b> You’re right, it’s a very broad category, and it’s definitely not for everyone. Sometimes the lack of constraints can actually exacerbate a manager’s-&nbsp;</p> <p><b>Mr. Goldberg:</b> Right.&nbsp;</p> <p><b>Ms. Alagic:</b> -weaknesses, so when we think about it, there are a couple of things that are key that we look for. Number one, you have to have access to that global opportunity set across regions, sectors, and currencies. Not only that, you have to also have a very strong keen sense of relative value between these different regions, which is challenging because, as you know, the fixed income market is very fragmented. The next thing is you have to have a strong risk management culture. Right? So you have to be able to point out which global macro factors are currently driving markets. You have to be able to size your positions correctly. And you also have to be able to look at correlations between different sectors, regions and so on. And then finally, and I think this is the least intuitive piece for most people,&nbsp; is you have to be very tactical. Typically, people think of fixed income as being a very sleepy asset class, right, but as an-&nbsp;</p> <p><b>Mr. Goldberg:</b> Like just kind of set it and forget it, and-&nbsp;</p> <p><b>Ms. Alagic:</b> Exactly, exactly. But as an unconstrained manager, you have to be willing to trade as frequently as is necessary to generate the best return opportunities.&nbsp;</p> <p><b>Mr. Goldberg:</b> Okay. That makes a ton of sense, but one final question if I may. You’re certainly not advocating that investors dump all their traditional fixed income and then just replace it all with-</p> <p><b>Ms. Alagic:</b> No [Laughing].&nbsp;</p> <p><b>Mr. Goldberg:</b> -unconstrained.&nbsp;</p> <p><b>Ms. Alagic:</b> No, definitely not. I mean, the issue with benchmarked traditional core fixed income right now like the Barclays AG is that you’re just taking a lot more interest rate risk and getting paid a lot less in terms of yield than you did before, but that benchmark fixed income exposure still has an important place in the client portfolio. It’s just that if you add unconstrained strategies, it can help a lot in terms of diversifying your sources of risk and return. And the other thing that I’d like to point out is that as we mentioned before, not all unconstrained managers are created equal, and we take a lot of pride in the platform that we have here at J.P.Morgan, where we do tons of robust due diligence to make sure that we isolate those top performers in the unconstrained manager set for our clients.&nbsp;</p> <p><b>Mr. Goldberg:</b> Irena, thank you so much. I took a lot away from that. It’s a difficult environment, but there are areas of opportunity and it sounds like through our process, we think that we can identify managers who can look overseas, expand that opportunity set, that have the risk discipline to go out and do that effectively. So thank you so much, and thanks everybody for joining. We’ll see you next time.&nbsp;</p> <p>[END]</p>

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