‘Contrarian’ who won big on Irish bonds thinks markets are wrong again
The flip-side of falling interest rates and bond yields has been a rally in the bond markets.
As yields drop, bond prices rise, and in recent months, owning US government debt – known as treasuries – has been an easy way to make money.
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So it has been a tough time to hold the view that the long era of low rates – which began with the financial crisis more than a decade ago – is about to reverse.
Few prominent investors have been punished harder for this contrarian stance than Franklin Templeton’s Michael Hasenstab, who manages funds with total assets of about $115bn (€104bn), including the Templeton Global Bond Fund.
He is not only less bullish than most bond managers; he is actively shorting treasuries, making bets that interest rates will rise and bond prices will fall.
This puts him at the epicentre of a debate that has split global markets.
If he is right, the world economy is turning a corner, central banks will finally be able to raise interest rates back to their pre-crisis levels, and global bond yields will stop grinding ever lower.
If he is wrong, it may be because the global economy is too weak for central banks to stop trying to pump it up.
So far, the scoreboard does not look good, either for the economy or Mr Hasenstab.
After increasing rates for the first time in almost a decade in 2015, the US Federal Reserve is back to cutting them, and the Templeton Global Bond Fund has lost 4.8pc in the past month.
The damage was partly offset by holdings in emerging market currencies, until some of those – most notably Argentina – also started to sour this month.
Mr Hasenstab’s position started out small but has been growing steadily over the past two years, quietly becoming the biggest bet against treasuries of any major global
He shorts treasuries by buying interest rate swaps, a contract investors use to speculate on the level of rates in years ahead.
Mr Hasenstab’s unwavering argument has been that economic strength in the US will make today’s low-yielding bonds less attractive, especially if consumer prices start to rise.
The short position “hedges the risk that rising inflation, a high reliance on foreign investors to fund increasing budget deficits, and highly stimulative monetary policy at a time of solid growth
and record employment could push longer-term interest rates higher, even while
shorter-term rates remain low and anchored,” he wrote in an email.
The economics that Mr Hasenstab studied to earn his PhD might suggest that this is a pretty straightforward view to take, but textbook economics is not necessarily the best way to navigate the current market.
Take the past month, when the Federal Reserve cut the key rate, despite still-solid growth in the US economy.
And then there is the curious phenomenon of negative interest rates in Europe and Japan, where investors are willing to sacrifice a small portion of the money to keep it safe.
That has also tended to pull US bond yields lower; when it actually costs money to lend to the German government, many global investors are happy to be paid even the yield of less than 1.6pc that 10-year treasuries offer.
Other prominent investors, such as Guggenheim Partners’ Scott Minerd, have also questioned the economic logic of Fed rate cuts at a time of economic strength.
“By almost every measure, policymakers should be considering another rate hike in anticipation of potential economic overheating,” he wrote in a commentary on the $270bn asset manager’s website last month.
Trying to predict where rates are headed in the current environment is a “fool’s game”, according to Gershon Distenfeld, co-head of fixed income at AllianceBernstein in New York.
Even if it becomes clear that rates are going to rise, yields will not necessarily go up in a straight line, he argues.
“Who the heck knows what will happen with bond yields?” Mr Distenfeld asks. “No one thought yields would go this low. Six months ago, we were talking about how much they were going to go up.”
Mr Hasenstab is no stranger to taking risks, though, and some of his past wagers on government bonds in such countries as Ireland and Hungary have delivered spectacular returns.
And when bond yields have shot up in recent years, such as in the aftermath of the US 2016 presidential election, the fund has handily outperformed its peers.
“It’s a very aggressive, high-return strategy that investors need to be patient with,” says Karin Anderson, director of manager research at Morningstar, which gives its top analyst rating of gold to Templeton Global Bond Fund.
“They have really dug into this position, and I don’t know that they’re going to walk away from it any time soon, because they don’t agree with the Fed’s approach of being so concerned about external factors, rather than actual US growth.”
Still, Ms Anderson says, if the treasury short continues to grow, and treasuries continue to rally, Morningstar might consider putting the fund under review.