Hello and welcome to the Download. I’m your host, Dave Richardson, and I am joined, I’m catching up with a very special guest, a good friend of the podcast, a voice you’re going to recognize if you listened to previous episodes: Mike Reed from BlueBay Asset Management, from across the pond. Mike, welcome back.
Good afternoon Dave. How are you?
I’m very well. How are you today?
Keeping well here in England.
Very good. And you’re a little bit ahead of us on the curve over there. So I think that’s good news. Maybe, maybe not?
I think maybe. In some ways, good, I suppose. We’re hoping we’re sort of at the back end of it now. But who knows? We are now going into a situation where we had the big peak in April, when a lot of Europe did. But now we seem to be having these localized breakouts and hotspots. They shut the city of Leicester down. There are a lot of these clothing and garments factories there. And I think it spread there. We’ve had a couple of situations, food processing, one with 100 people this weekend. So who knows? They’ve opened the pubs, which is a good thing I suppose. At least we can go and have a drink, but we have a drink outside though. But it’s still very nervous over here. There are a lot of disputes, discussions whether or not people should wear facemasks. People are anxious. So we’ll see what’s going to happen.
Yes that’s one of the nice things about England, you can stand outside at the pub and have a pint. And really the crisis is what I wanted to cover off today at BlueBay specialists in fixed income. I wanted to ask you about how you and your colleagues at Blue Bay managed through the crisis in your fixed income portfolio. How did you cope with what was going on through the height of the crisis?
Well, I guess if I am honest, when we came into the crisis in January, February, when it was starting to brew, we were still quite constructive about risk. The economy seemed to be going well. We felt that Trump was going to prime things ahead of the election, which he seemed to be doing, and things seemed to be quite well. Then we started to monitor it quite closely as we started to see some of the reports come out, we started to get a bit more apprehensive during February. And I know that we were in discussions with the RBC senior economics team as well, coming through it with them, having daily updates on the numbers. Starting to be a little bit more cautious towards the middle then we started to take some more risk. But we still were running a little bit too much risk. I guess it really blew up at the back end of February when we suddenly had an explosion in cases after the school half term holidays here in Europe, when large numbers of people travelled to go skiing and people returned back to their home countries. And then it was like wildfire here. And I think that’s when we realized this is a serious problem and we need to act. We probably, on the wrong side, had too much risk on, in hindsight. That’s where we were. But then it’s how you react when you get into it that really matters. And the first thing is not to panic. So when we look at what we know, let’s go back to see what other things we could do. What playbooks can we get? So we look back to 2008 as obviously the most recent example of what’s happened. And obviously that was a financial crisis rather than a health crisis. But you go through your portfolio and it’s a case of not throwing the baby out with the bath water. You have to be quite brutal and take a scalpel to things where you need to. And when things have changed you have to change your position. So what became very clear from our analysis, things like airlines, things like leisure, this was going to be a really big, big hit to them. And so we moved very quickly where we had exposure there to move them out as quickly as we could. But then once we got to there, we then definitely underperformed for a period of time. But we knew that was going to happen because there’s only a certain amount you can do, because some of the panic that goes on there and other people who are overly leveraged, were in a very bad state. There is a fund in Europe, H2O, which had a huge amount of leverage with liquid positions, and they were down 50 % in the first few weeks. And when they are being forced sellers, there are no bids out there. There are only bids out there for things that you don’t really want to sell. We don’t use leverage, which helps us. And so we were careful and we looked through. In the financial crisis, what paid you was to get close to the central banks because the central banks will act. The central banks had themselves a playbook from 2008 on what to do. In 2008, 2009, they took a while to sort it out, especially in Europe. It took a long time to work out what to do. The Fed in the US, if you remember back then, didn’t get it straight away. And there were some rocky times, but they had a playbook. They knew what they were going to do. And they did the same. So we’re like, okay, our mantra was: stay close to the central banks. The central banks will not let credit fall apart. They started with a government bond market when they started to get some tensions there and some of the libel rates and stuff. Then it was going to be senior fixed income, it is going to be investment grade companies. Those were the very obvious ones for them to support, investment grade companies. Once you let the credit, it becomes self-perpetuating. Once the credit gets choked, then companies die very, very quickly and you can make very, very bad decisions in difficult times. So when the authorities act and they did again to support investment grade, we were close to that. We thought that would happen. And the same in Europe where they reopen the bond buying program. So that really helped us and we were well positioned for that. And we got our portfolios concentrated around there. What we also did was, we were looking to reduce sovereign exposure, the rush to high-grade sovereigns. It works for a very short period of time. But in Europe, you have to remember, these are severely negative rates we’re talking about here. When you’re lending to Germany and you’re paying 50, up to 100 basis points a year to lend them money, you are in guaranteed loss-making trade. And that’s because people are forced into those trades, because they have to hold those. But we have the ability to think about that and move away from that. Then you move down the spectrum side. You start to look at high yield stuff, especially stuff that’s being forced out of investment grade into high yield, and the «fallen angels». There’s suddenly a big market that’s grown there. Again, we know those companies where fundamental is at. And we look from the bottom up. We work with that. And so that really paid us, we moved to high yield. Our high yield teams, I have to give a huge shout out to them. They have done phenomenally well. Some of the panic that went on and some of the prices, they didn’t panic. They put cash to work where they had it. They moved from very safe credits, which were the obvious ones, into more risky ones, where they started to think the balance has come in favour, especially in a high yield team in Europe. I think they’re 400, 500 basis points ahead of benchmarks this year. And that is again an issue. One of the things is the default rates. The default rates in Europe are much, much lower than the US. It’s a very different basket of bonds in high yield. In the US we’re expecting default rates to be about 9, 10 % this year. In Europe, it’s going to be about 2,5%. So suddenly you’re being paid to hold that risk. So it’s very interesting. That’s where we are. We’ve done well, we recovered. Of course, when we’re looking at all our portfolios, — I had a little look yesterday —, I think we are at 97%. All the assets that we manage for RBC funds are ahead of benchmark year to date now.
Excellent. Well, Mike, that’s a tremendous update. And there’s so many different directions I’d like to take but I want to be respectful of your time. We’ll get you on again. But I think one of the key things that you said and some of the other investment managers that we’ve had on the podcast in recent weeks have all come back to almost the same line which is: we did not panic. And that’s exactly what investors can learn from the professionals. When you get into a situation where, as you said, and some other managers have said, we weren’t exactly where we wanted to be coming into this, but as soon as things started to happen, we didn’t panic. We took a step back. We looked back at things we could learn from in the past. We developed a plan very quickly and then executed. And we were able to take a difficult situation and actually turn it into a positive one for investors. So that’s a great story. And Mike, again, we’ll have you on. Thank you, though, for coming on. Great to hear from you. We missed you coming over to Canada to visit us. Hopefully that’s going to happen soon.
I hope so. I was out there in February just before it all kicked off. So at least I got a trip in this year. So I’m not sure we’re going to make another one. As I said when I was chatting to you the other day Dave, if I did come out now I’d have to go to quarantine for two weeks when I come back so I don’t think that’s going to happen for a while.
Well, we don’t want that. We never want to have you working that hard. But, Mike, thanks for your time today. And hopefully we’ll have you back soon. All the best.
Lovely to speak to you Dave. Take care.