long bond price volatility can be trading opportunity
Manager profile
Manager: Christine Horoyski, Aurion Capital Management
Funds: Aurion Income Opportunities Fund/Dynamic Aurion Total Return Bond Fund
Description: Diversified portfolio of fixed-income securities with an emphasis on investment-grade corporate bonds
Firm's AUM: $6.1-billion
Performance: 1-year: +11.2% (Aurion Income Opportunities Fund, as of Jan. 31, 2012, )
Fees: Management: 0.85% of NAV (Class A); Performance: 10% of excess positive return above DEX Index
Despite recent good news out of Europe and North America, investors appear to be maintaining a hedge against another macro shock, such as higher oil prices, by staying invested in the presumably safe bond markets of Canada, the United States and Germany.
Christine Horoyski, head of fixed income at Aurion Capital Management, considers the low-yielding government bond market expensive. As a result, she and her colleagues, Derek Johnson and Nicole White, are maintaining an underweight position. "Government yields on terms under five years yield less than 1%, reflecting the view that policy rates are on hold for the next two years," Horoyski said. "They hold little value for investors other than as an insurance hedge."
Yields on longer-term government bonds are also low in the 2% to 3% range. How-ever, the portfolio manager notes that they have significantly more price volatility than shorter-dated bonds, presenting a trading opportunity for active managers such as herself.
In fact, there have been 11 occasions since fall 2011 where buying long bonds would have produced price gains of more than 3% in the span of about a week. "The trading range remains intact, so I remain an active buyer and seller of government bonds," Horoyski said.
Since credit conditions have normalized to a large extent, the manager expects both corporate and high-yield bonds to reflect a more normal risk/return trade-off.
"Corporate bonds remain attractive based on the excess yield over government bonds, credit fundamentals and an improving economy," she said, adding she anticipates their returns in 2012 will be similar to current yields of 4% to 7%. "The excess yield of corporate bonds will continue to provide a margin of safety against rising bond yields, and the continued demand for income in a low-yield environment is supportive of this portion of the fixed-income markets."
As a result, Horoyski's portfolios have an average combined exposure of 60% in investment grade and high-yield bonds.
Buys
Government of Canada real return Bond (1.5%, 2044)
The position: 3% of fund.
Why do you like it? This position serves as an inflation hedge in Horoyski's portfolios. It is also a way to express the view that the current spike in oil prices may lead to higher near-term inflation expectations. The manager actively buys RRBs and TIPS when inflation expectations look too low and sells them when inflation expectations climb. "RRB prices fell over the past month and represented a good entry point to add back the position into our portfolio," she said.
Biggest risk: The economy slows and inflation eases.
PetroBraS (5.375%, Jan. 27, 2021)
The position: 1% of fund.
Why do you like it? The Brazilian energy giant is the largest company by market cap and revenue in latin America, holding oil and gas assets in 18 countries on four continents. "This holding is an indirect way to gain emerging market debt exposure with a more attractive yield than the country (1% higher), a higher rating than the sovereign, and with a debt pro-file that is in line with North American peers," Horoyski said. While she purchased this as a new issue in U.S. dollars, the currency exposure is hedged back into Canadian dollars.
Biggest risk: Brazil's sovereign risk and a collapse in oil prices.
Sherritt international CorP. (8%, nov. 15, 2018)
The position: 1.5% of fund.
Why do you like it? Horoyski bought in November 2011, after holding some of Sherritt's shorter-term debt that was called early at a 2% premium. "The company continues to see good top-line growth in revenue on the back of higher commodity prices," the manager said.
Biggest risk: Bringing the Ambatovy nickel project in Madagascar online, which appears on track.
sell
u.S. 10-year Bond futureS
The position: 13% short position.
Why don't you like it? Horoyski uses the bond futures market to express a tactical view on interest rates and to hedge interest rate risk in her funds. She actively trades the volatility in the government bond market and finds the bond futures market an efficient and cost-effective way to capitalize on price volatility.
The manager also uses futures to shorten the duration (or interest rate sensitivity) of her long bond positions, which are currently mostly corporate names.
