The Alt Ucits convertibles sector has been a tough one to outperform in. Over the three years to the end of August 2017 the average manager has returned a modest 3.5% in euro terms.
RWC’s Davide Basile is one of just two rated fund managers in the sector, having returned 6.1% over the three-year period. So how has his RWC Core Plus fund trumped his average rival following a difficult 2016?
Basile describes the challenge, characterised by large swings in the market: ‘Sectoral skews within the convertible bond space, such as underweights in energy, drove a year of outperformance for the asset class in 2015 as oil sold off aggressively. However, this was followed by a year of lacklustre performance in 2016 as oil recovered and stabilised,’ he says
‘As a result, interest in the asset class was muted at the beginning of 2017. However, some tactical investors saw that the asset class’ risk exposures – namely low interest rate and credit sensitivity, conservative exposure to equity markets, and exposure to volatility – were beneficially aligned in a reflationary environment.’
The sector’s relatively complex outlook has drawn a mixed response from fund providers. This year both DNCA and Invesco have launched standard convertible bond strategies, while BlueBay has closed its emerging markets convertible fund due to a drop in assets.
But Basile, who co-runs the RWC fund with Esther Watt, says the nervous view of the sector does not change its impressive fundamentals. ‘The attractive risk-adjusted return of the product over time makes it popular strategically with long-term institutional investors such as pension funds and private wealth managers,’ he says.
A-rated Basile, has delivered steady performance this year, with just a slight negative dip in June, and says his fund has gained from several different positions.
‘The fund has broadly benefited from its conservative exposure to equity markets year-to-date. June was an interesting month for markets as the Bank of England surprised with a more hawkish tone, and the ECB followed suit.
'As such, global bond yields moved higher and the euro strengthened 1.7% versus the dollar, the combination of which saw European equities underperform with the Eurostoxx down 3.2%. Given our skew towards Europe we felt this in performance, but good name selection limited the fallout.’
Europe is currently the fund’s biggest long exposure, and the strategy has around 12% of assets invested in the region. At a time when talk of the ECB tapering, unwinding QE, rate rises in the US and political instability is rife, Basile currently has the fund’s duration at 0.7%, a move he says is a precaution.
‘North Korea aside, political risk has subsided significantly this year and global growth has surprised to the upside. More importantly, growth is coming through in an increasing number of regions and unemployment is falling. It strikes us as sensible to begin to unwind the extreme measures that central banks took to provide liquidity to the monetary system post the financial crisis.
‘However, given the lack of inflationary pressures coming through, officials are clearly wary of making any policy mishaps. Euro strength and sterling weakness further complicate decision-making and communication for the ECB and Bank of England,’ he says.
In this reflationary environment, with central banks still erring on the side of caution, Basile says the team believes risk assets will continue to inch higher.
‘As monetary policy is slowly tightened we see an increasing likelihood of a pick-up in volatility, in fixed income as well as equity markets.
‘The risk for more traditional fixed income assets is greater given that the income generated is no longer sufficient to offset capital loss from price depreciation as interest rates rise. This is why we are running a low duration,’ he says.
Away from monetary policy, Basile has a clear focus on Asia. Around 8% of the fund is allocated to the region, as he believes China, for example, has a dynamic economy which will continue to grow at a high pace relative to developed markets.
‘The government takes a structured approach and is moving in the right direction with state-owned enterprise reform and the central bank’s communication is clear for the most part.
‘We have exposure to financials, consumer discretionary, industrials, real estate and utilities in the region, mostly through convertible bonds issued by corporates with strong credits and attractive equity fundamentals that are unrelated to tensions in Korea.
Play to your strengths
Basile says market conditions such as these, together with the reflationary global economic environment, are a real bonus for convertible bond strategies.
‘A big opportunity for us is the fact that interest rates are low but slowly rising and equity markets are appreciating, but with the potential for volatility to pick up. This plays to the strengths of the convertible bond asset class, particularly for active fund managers.
‘The fund has a relatively low duration and gives the holder equity market exposure through optionality, enabling both capital appreciation to the upside and capital protection to the downside. This optionality itself becomes more valuable as volatility increases, adding to returns.’
This article orginally appeared in the October edition of the Citywire Selector magazine.