October 2022 / INVESTMENT INSIGHTS
A Flexible Bond Approach to Help Navigate Volatile Markets
How the T. Rowe Price Dynamic Global Bond Fund may help during this challenging environment.
This year has been extremely challenging for bond investors, and volatility is set to continue as markets prepare for life without central bank support. We believe this environment will suit our absolute bond return approach, which is flexible, has a strong emphasis on active duration management, and employs defensive hedges to provide diversification against risk assets.
Volatility Is Set to Continue
Tough Period for Global Bond Markets
(Fig. 1) Fixed Income returns (AUD-hedged %) – year to date
As of 30 September 2022. All Index returns are total returns.
Past performance is not a reliable indicator of future performance.
Source for Bloomberg index data: Bloomberg Index Services Ltd. Copyright© 2022, Bloomberg Index Services Ltd. Used with permission.
Asset class' representative benchmark: European High Yield - Bloomberg Pan-European High Yield Index, UK Gilts - Bloomberg UK Gilt Index, US High Yield Credit - Bloomberg US Corporate High Yield, US Treasures - Bloomberg US Treasury Total Return Index, German Bunds - Bloomberg Germany Treasury Bond Index, Bloomberg US IG Credit - Bloomberg U.S. Corporate Investment Grade Index, EM High Yield Corps - Bloomberg EM USD Corp + Quasi-Sov High Yield Index, AU Investment Grade Credit - Bloombery AusBond Credit 0+ Yr Index, AU Governments - Bloomberg Australian Treasury Index; Japanese Governments - Bloomberg Japan Government Bond Index - Chinese Governments: Bloomberg China Treasury Index.
It has been a tumultuous few quarters in fixed income, with sovereign bond yields rising sharply and almost every segment of the asset class declining (see Figure 1). The unprecedented moves have left many investors questioning how much longer the rout can continue. Although it is difficult to envisage further moves of the same magnitude, particularly in sovereign bond markets, this volatile period is far from over. We have entered a new fixed income regime as markets prepare for life without the support of central banks.
Across developed markets, central banks are responding to multi-decade high inflation by withdrawing liquidity and hiking interest rates. Furthermore, some central banks, most notably the U.S. Federal Reserve, are also reducing their balance sheets. This all comes at a time when economic growth is slowing.
Against this backdrop, it is difficult to see how volatility in bond markets will ease anytime soon—on the contrary, we believe it is here for the long term. In the current climate, we feel that central bank tightening is more fairly priced in sovereign bond markets and that we are moving closer to the point where there’s a potential window of opportunity to add duration. By contrast, in risk markets, such as credit, we remain cautious on the outlook as the environment of slower growth and higher inflation is likely to cause credit fundamentals to deteriorate. Therefore, we expect volatility to continue with potential for credit spreads to widen further. While this could be challenging, at some point there is likely to be an inflection point at which valuations become attractive again and strong potential buying opportunities emerge in the credit space.
We believe that this new regime requires volatility management. In the T. Rowe Price Dynamic Global Bond Fund, we implement defensive hedging positions in seeking to help anchor performance during periods of risk aversion. Flexibility will also likely be essential in this environment. Heightened volatility may result in prices becoming dislocated, so our ability to be tactical can be beneficial. This proved to be the case in March 2020, when we responded to a huge sell-off in credit and added select corporate bond exposures that were dislocated from fundamentals and identified as attractive by our bottom-up research process.
What’s Your Diversifier?
(Fig. 2) Growth of $ in Dynamic Global Bond Fund vs Global Aggregate Index AUD-hedged
As of 31 August 2022.
Past performance is not a reliable indicator of future performance.
For illustrative, informational purposes only. This is not intended to be investment advice or a recommendation to take any particular investment action.
The chart illustrates the fund’s and index’s performance based on how a hypothetical $1 investment would have grown over time. Figures shown in AUD.
Cumulative Returns since 28 February 2014.
Source for fune performance: T. Rowe Price. Gross-of-fees performance is the net return with fees and expenses added back. Net-of-fees performance is based on end-of-month redemption prices after the deduction of fees and expenses and the reinvestment of all distributions.
Figures include changes in principal value. Investment return and principal value will vary, and an account may be worth more or less at termination than at inception.
Source: Bloomberg Index Services Limited (See Additional Disclosures).
Please note: The Dynamic Global Bond Fund (DGB) mentioned herein refers to the T. Rowe Price Dynamic Global Bond Fund - I Class (Gross of Fees).
Global Aggregate AUD-hedged is the Bloomberg Global Aggregate AUD-hedged Index.
The indices shown are not the formal benchmark of the Fund. They are shown for comparison purposes only. The Fund's benchmark is Bloomberg AusBondBank Bill Index.
Time to Rethink Risk Diversification
Fixed income markets are going through a period of strategic change as central banks retreat from supporting markets. This environment means that investors can no longer rely on the post-global financial crisis investment playbook and will need to think differently—particularly regarding diversification. At times this year, stocks and bonds have both sold off simultaneously, demonstrating that the stock/bond relationship is not always constant and can change, especially in the current climate where central banks are withdrawing liquidity support. Given this, we believe that it will be vital for portfolio managers to adapt to the changing nature of correlations to avoid suffering losses from both major asset classes at the same time.
In the T. Rowe Price Dynamic Global Bond Fund, we do not assume that fixed income will always be a diversifier that typically performs well when risk markets such as equities sell off. Instead, we focus on actively managing the portfolio and maintaining a liquid profile. This provides us with the flexibility to adapt to changes in market conditions. We also consider the full toolkit available to help with diversification efforts, including using currency and derivatives markets alongside traditional interest rate management.
Performance Table
(Fig. 3) T. Rowe Price Dynamic Global Bond Fund (I Class)
As of 30 September 2022.
Past performance is not a reliable indicator of future performance.
Figures are calculated in Australian dollars.
*Source for performance: T. Rowe Price. Net-of-fees performance is based on end-of-month redemption prices after the deduction of fees and expenses and the reinvestment of all distributions.
Figures include changes in principal value. Investment return and principal value will vary, and an account may be worth more or less at termination than at inception. For further details, please refer to the fund’s product disclosure statement and reference guide which are available from Equity Trustees or TRPAU.
Source for Bloomberg index data: Bloomberg Index Services Limited (See Additional Disclosures).
‡ Since inception 18 February 2014.
Benefits of Active Duration Management
(Fig. 4) Return analysis of the T. Rowe Price Dynamic Global Bond Fund (I Class) (Gross of Fees) during rising rate environments
This was not a one-off: Our track record of outperforming during periods of rising rates is strong. During the last bond market correction in January 2021, for example, the U.S. 10-year Treasury yield rose more than 50 basis points (bps), while the fund gained more than 2%. Indeed, the fund consistently outperformed during some of the largest bond market corrections since its inception (Figure 4). Again, we have achieved this primarily through our active management of duration, which allows us to implement both long and short positions, including cutting overall duration to zero. This gives us the flexibility to adapt to different market cycles and environments, including rising rates.
As of 30 June 2022. Figures are calculated in Australian dollars.
Past performance is not a reliable indicator of future performance.
Source for fund performance: T. Rowe Price. Gross-of-fees performance is the net return with fees and expenses added back. Net-of-fees performance is based on end-of-month redemption prices after the deduction of fees and expenses and the reinvestment of all distributions.
Figures include changes in principal value. Investment return and principal value will vary, and an account may be worth more or less at termination than at inception.Index Performance is computed in U.S. dollars and converted to the currency shown using an exchange rate determined by an independent third party.
*Periods selected represent accelerated increases greater than 25 bps in the yield of the generic US 10-year Treasury Note where bond markets have moved meaningfully in a short period of time (i.e. below 60 trading days).
Source: © 2022 Refinitiv. All rights reserved.
Benefits of Diversification
(Fig. 5) Return analysis of the T. Rowe Price Dynamic Global Bond Fund (I Class) (Gross of Fees) during equity market sell-offs
We also consistently outperformed during periods of negative equity market returns, which demonstrates our ability to manage downside risk and act as performance anchor when risk markets correct. During February and March 2020, for example, when coronavirus pandemic fears triggered a major sell-off, the fund returned over 4.3% while the S&P/ASX 200 Index fell by almost 27%. Since inception, the fund outperformed the ASX/S&P 200 Index in several of the largest equity market drawdowns (Figure 5). We achieved this not only by allocating to high-quality fixed income assets (which typically have a low correlation to equity markets), but also by implementing specific defensive strategies involving currency and credit markets to anchor performance during times of stress.
As of 30 June 2022. Figures are calculated in Australian dollars.
Past performance is not a reliable indicator of future performance.
1 Source for fund performance: T. Rowe Price.Gross-of-fees performance is the net return with fees and expenses added back. Net-of-fees performance is based on end-of-month redemption prices after the deduction of fees and expenses and the reinvestment of all distributions. Figures include changes in principal value. Investment return and principal value will vary, and an account may be worth more or less at termination than at inception.
*Periods selected represent accelerated negative moves greater than 5% in the S&P/ASX 200 index (total return) where equity markets have fallen meaningfully in a short period of time.
Sources: © 2022 Refinitiv. All rights reserved, S&P and analysis by T. Rowe Price (See Additional Disclosures).
Why the Dynamic Global Bond Capability?
In the T. Rowe Price Dynamic Global Bond Fund, we seek to achieve three core goals:
- Provide a regular return;
- Act as a diversifier during times of market stress; and
- Manage downside risks such as rising interest rates.
The volatile market conditions experienced so far in 2022 have provided an important test of our approach, and we have delivered on these goals. The fund produced a positive return during the first nine months of 2022 at a time of a deep bond market sell-off and heightened volatility across risk markets. Our use of active duration management was central to this achievement, as we dynamically managed exposures over the period. This approach helped us deliver gains from a variety of positions, including short positions in select developed market sovereigns, allocations to inflation-linked bonds, and occasional tactical long exposures.
Gross of Fees1 Cumulative Returns since 28 February 2014
As of 30 June 2022. Figures are calculated in Australian dollars.
Past performance is not a reliable indicator of future performance.
1 Source for fund performance: T. Rowe Price. Fund performance is shown in I Class. Gross-of-fees performance is the net return with fees and expenses added back. Net-of-fees performance is based on end-of-month redemption prices after the deduction of fees and expenses and the reinvestment of all distributions. Figures include changes in principal value. Investment return and principal value will vary, and an account may be worth more or less at termination than at inception.
Sources: Bloomberg Index Services and © 2022 Refinitiv. All rights reserved. Please see Additional Disclosures page for information about this Bloomberg information.
Source: T. Rowe Price.
Looking ahead, we expect volatility to persist. The market environment remains highly uncertain, with worries continuing over geopolitics, slowing growth, rising inflation, and tightening financial conditions.
While this is likely to be challenging, we expect great buying opportunities to emerge at some stage. Beyond simply navigating a new higher-volatility regime, it will be crucial to identify when a potential inflection point emerges. Overall, we believe these are the conditions the fund is designed for, with built-in flexibility, a broad approach, and a strong emphasis on volatility management.
Additional Disclosures
“Bloomberg®” and Bloomberg Indices are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by T. Rowe Price. Bloomberg is not affiliated with T. Rowe Price, and Bloomberg does not approve, endorse, review, or recommend this product. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to this product.
The S&P 500 Index & ASX/S&P 200 is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). This product is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index & ASX/S&P 200 Index
IMPORTANT INFORMATION
This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
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September 2022 / INVESTMENT INSIGHTS
October 2022 / INVESTMENT INSIGHTS
Arif Husain is head of International Fixed Income at T. Rowe Price. He is lead portfolio manager for the Dynamic Global and Global Aggregate Bond Strategies.
