Issued in June 2016
For Professional Investors and Advisers Only
Monthly Newsletter
Schroder ISF* Strategic Bond
Covering May 2016
Performance %**
May
2016
1 year
3 years
(p.a.)
5 years
(p.a.)
Schroder ISF Strategic Bond
(A Accumulation shares)
0.9
-2.0
-1.0
0.7
Schroder ISF Strategic Bond
(I Accumulation shares)
1.0
-0.8
0.2
1.9
Benchmark: USD LIBOR 3
Months
0.1
0.5
0.3
0.4
**A & I Share performance net of fees, NAV to NAV (bid to bid)
Source: Schroders, Bloomberg, as at 31/05/16, USD returns
Market overview
Bond investors were relatively cautious in May;
balancing broadly positive developments in
macroeconomic data with several reminders that
the Federal Reserve (Fed) is mulling its next rate
rise. The comments took the policy trajectory for
the US even further from other major central
banks. The European Central Bank (ECB) took
steps to further support the eurozone’s financial
system in May, while China revised expectations
for its economic trend. The world’s second largest
economy is now expected to follow an “L-shaped”
recovery rather than a more positive “U” or even
“V” shape. The more clouded backdrop was
reflected in sovereign bond movements over the
month. Treasury yields were broadly higher, while
government yields elsewhere fell. Corporate
indices underperformed government bonds.
Q1 GDP growth for the US was revised upwards in
May, from 0.5% to 0.8% (quarter-on-quarter
annualised). While still appreciably slower than the
growth rate of 2.4% in Q4, the weakness has
become typical of Q1 seasonality in recent years.
In each of the past four years, US growth has
dipped in Q1 only to rebound in Q2. New home
sales and retail sales data were positive, and
inflation figures – both headline and excluding fuel
and food prices – improved. Short term
expectations of a Fed rate hike declined after a
weaker non-farm payrolls number, despite
comments from the Fed itself that the next rise
should be expected in “coming months”.
There was more of a sense of hiatus in the UK and
eurozone; as markets awaited developments in
both the UK’s EU referendum and the ECB
corporate bond purchases – both June events. In
the interim, economic numbers from both regions
were broadly positive. In Europe, the ECB held
existing policy as it was as economic data continue
to improve slowly. GDP growth improved from
0.3% (quarter on quarter) in Q4 to 0.5% in Q1.
Purchasing managers’ indices from both the UK
and eurozone were improved.
The fragility of China’s economy was restated in
May, with key April data slowing more than
expected and dampening optimism built by
March’s better numbers.
Sovereign bond yields beyond US shores were
lower overall given multiple sources of uncertainty
stated above. The 10-year Treasury yield rose
from 1.83% to 1.85%. The 10-year gilt yield
declined from 1.60% to 1.43% and the 10-year
Bund yield fell from 0.27% to 0.14%.
Global corporate bonds generated positive total
returns but underperformed government bonds.
The BofA Merrill Lynch Global Corporate index
made total returns of 0.1% (excess returns over
government bonds -0.1%). The equivalent high
yield index gained 0.6% (0.6% excess returns).
Portfolio overview
The portfolio generated a positive return in May.
The bulk of the positive return was contributed by
the portfolio’s active currency exposures. We
continue to hold a variety of trades favouring the
US dollar (USD) against other developed
currencies. All directional positions favouring the
US dollar generated positive returns. The trades
favouring the US dollar against the euro (EUR) and
Japanese yen (JPY) were strongest. Positions
against the Australian dollar (AUD) and Singapore
dollar were also positive.
We rotated a position favouring the Mexican peso
(MXN) against AUD into a position favouring USD
against AUD, as we felt our exposure to Mexico
was too high. We continue to believe that the US
dollar and Mexican peso will continue to trade
within a range, and this position remains in place
from last month. The view detracted slightly in
* Schroder International Selection Fund is referred to as Schroder ISF throughout this document
1
Issued in June 2016
May. We continue to trade EUR against USD on a
tactical basis.
Country trades remain modest in terms of risk
allocation, but contributed positively this month.
The position favouring sterling rates relative to the
US remains active on a strategic and tactical basis,
as further Fed rate hikes are fundamentally better
supported than any such policy tightening in the
UK. In May, we briefly held a position in a newly
issued long dated Spanish government bond, as
the issue was attractively priced. The position was
closed at a profit within the month.
We introduced a position in the sterling breakeven
in May, as we do not believe that existing inflation
expectations in the UK are appropriately priced.
The position has contributed in the short term and
remains in place.
We continue to hedge the portfolio against a
material widening in credit spreads, given that a
number of systemic risks remain in play. The
position detracted modestly in May but remains in
place.
Outlook and strategy
The team’s current investment themes centre on
the importance of Fed inaction to ongoing market
calm. The Fed’s dovish turn in March led to a
decline in the risk aversion which drove market
weakness in the opening of 2016. Improvement in
economic data and a recovery in commodity
markets have contributed, but the Fed’s cautious
view and the short term reversal of the US dollar’s
strength were key to the continued improvement in
sentiment. However, it is important to remind
investors that the rise of the US dollar was, and
remains, fundamentally supported.
The initiation of a tightening cycle by the Fed at the
end of last year remains justified by the strong US
labour market and ongoing economic expansion.
An uneasy policy truce may have descended upon
central banks for the time being, but it remains to
be seen how long it will last. The Fed must weigh
the positive global impact of leaving rates as they
are with the growing domestic necessity of
reaching a neutral base rate.
Elsewhere, the Bank of Japan still appears to be
the most probable candidate to extend
unconventional monetary policy even further in the
coming months, while the ECB, Bank of England
and People’s Bank of China remain highly cautious
in their policy approach in a less certain growth
environment.
Structurally, many of the impediments to a more
sustainable and robust global economic backdrop
persist. Debt is still unsustainably high in many
regions, investment is stubbornly weak, and the
changing mix of growth suggests productivity will
remain
subdued.
Structural
reforms
are
conspicuous in their absence, resulting in growth
2
For Professional Investors and Advisers Only
rates continuing to disappoint. With monetary
policy largely tapped out, risks to the global
economy are tilted towards the downside.
The team remains focused on exploiting tactical
opportunities generated as a consequence of the
uncertain market environment. As we have
discussed, some traditional relationships have
broken down. This offers active managers the
opportunity to take advantage of these dislocations
- over shorter-term horizons - to create alpha while
reducing longer term more directional, market risk
exposure. Furthermore, the diverse basket of riskoff trades in the portfolio should also help to
protect the portfolio from any further periods of
acute risk aversion.
Issued in June 2016
For Professional Investors and Advisers Only
Monthly Newsletter
Schroder ISF Strategic Bond
Fund data as at 31 May 2016
Team
Portfolio managers
Size and Holdings
Fund size in base currency
Number of issuers
Bob Jolly and Gareth Isaac
$1,902.4 million
189
Portfolio Statistics
Effective Duration
Spread Duration
Average OAS*
Average ASW#
0.04
1.57
105.13
101.57
*Option Adjusted Spread. #Asset Swap Spread
Fund data represents the fund’s holdings of bonds and net CDS
and Option positions respectively, in each ratings category. The
quality breakdown is based on the average credit ratings of
Moody’s, S&P, and Fitch
Asset Allocation (%)
Cash
Treasuries
Sovereign
Government Related
Securitised
Credit**
Unit Trust
Other derivatives***
0.9
16.8
1.6
14.6
18.5
20.0
0.9
26.6
Asset allocation breakdown includes cash and derivatives
Active Country Allocation (%)
USA
United Kingdom
France
Global
Germany
Canada
Mexico
Italy
Belgium
Sweden
Netherlands
Ireland
China
Spain
Emerging Mkts
Japan
Hong Kong
Bermuda
Other*
-63.4
17.0
7.6
7.4
4.1
3.6
2.8
2.6
2.6
2.3
2.0
2.0
1.8
1.0
0.9
0.8
0.6
0.5
2.9
The portfolio’s country of risk for active country allocation is the
US. *Includes Bermuda, South Africa, Austria, Iceland,
Switzerland, India, UAE, Taiwan, Norway, Barbados,
Singapore, EUR, Cayman Islands
Active Foreign Exchange Exposure (%)
USD
NOK
18.5
5.9
SEK
4.0
MXN
2.0
INR
1.9
GBP
0.2
*Exclusive of TBAs A TBA is a forward contract on a mortgage
backed security (MBS). Currently 0% exposure to TBAs. In
previous newsletters, Agency MBS and Non-agency MBS/ABS
have been separately reported. Henceforth they will be
combined.
AUD
-1.0
KRW
-1.9
JPY
-2.6
SGD
-4.9
** Includes single name credit default swaps, and credit default
swaps on indices. *** Includes currency forwards, inflationlinked swaps, options futures and synthetic derivative offsets on
futures and credit default swaps.
EUR
-22.0
Other*
-0.1
Breakdown is based on portfolio sub-accounts using BarCap
Level 1 and 2 classifications. **Liquidity assets
Source: Schroders Fixed Income Analytics; all data as at 31
May 2016. *Others include PHP, PLN, HKD and CAD
This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder International Selection Fund (the
“Company”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares. Subscriptions for shares of
the Company can only be made on the basis of its latest Key Investor Information Document and prospectus, together with the latest audited annual report
(and subsequent unaudited semi-annual report, if published), copies of which can be obtained, free of charge, from Schroder Investment Management
(Luxembourg) S.A. An investment in the Company entails risks, which are fully described in the prospectus. Past performance is not a reliable indicator of
future results, prices of shares and the income from them may fall as well as rise and investors may not get the amount originally invested.
Schroders has expressed its own views and opinions in this document and these may change. This document is issued by Schroder Investment Management
Ltd., 31, Gresham Street, EC2V 7QA, who is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped
or monitored. Risk Considerations: The capital is not guaranteed. Non-investment grade securities will generally pay higher yields than more highly rated
securities but will be subject to greater market, credit and default risk. A security issuer may not be able to meet its obligations to make timely payments of
interest and principal. This will affect the credit rating of those securities. Currency derivative instruments are subject to the default risk of the counterparty.
The unrealised gain and some of the desired market exposure may be lost. Investments denominated in a currency other than that of the share-class may not
be hedged. The market movements between those currencies will impact the share-class. Investment in bonds and other debt instruments including related
derivatives is subject to interest rate risk. The value of the fund may go down if interest rate rise and vice versa. The issuer of Mortgage or Asset backed
securities may have a limited ability to recover amounts due if the underlying borrowers become insolvent or their collateral drops in value. The Fund may be
leveraged, which may increase its volatility. The fund enters into financial derivative transactions. If the counterparty were to default, the unrealised profit on
the transaction and the market exposure may be lost.
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