Newton's global dynamic bond strategy - investment commentary

The strategy employs a highly dynamic, unconstrained approach to asset allocation across bond and currency markets. Its flexibility enables investors to take an opportunistic approach and to benefit from changes as they arise in those markets. It also promotes effective risk management and strengthens the strategy's resilience to changes in economic circumstances. The manager of the strategy seeks to deliver positive returns in portfolios by finding the best opportunities for investment in the following fixed-income asset classes: global government bonds, emerging-market sovereign debt, investment-grade corporate bonds, and high-yield corporate bonds.

Returns between and within bond markets have varied greatly in recent years. In 2008, returns from the strategy's reference universe1 were negative, with government bond markets generating strong returns and providing bond investors with scope to endure the market turbulence of that year, but credit and emerging-market bonds weak. Overall, three-quarters of the strategy's available asset classes generated negative returns in 2008. Against the reference universe, the strategy produced a positive return, but lagged the current target of 1-month GBP Libor + 2%, owing in part to a premature increase in exposure to corporate bonds.

In 2009, by contrast, returns from the reference universe were very strong, with high-yield corporate markets leading the way and emerging-market debt also performing very well. The year provided significant opportunities for flexible strategies that were able to buy credit and to take advantage of high prevailing yields.

The accumulation of corporate debt in the fourth quarter of 2008 prepared the strategy for the rebound that started towards the end of the first quarter of 2009.

Our global dynamic bond strategy has achieved its returns since inception by adapting to evolving market conditions. We believe that the next phase in fixed-interest markets will be different from the conditions we have witnessed in recent times, and that investors should focus on bond investments that are less likely to depreciate in an environment of rising interest rates. Amid the challenges that exist in the current economic setting, we believe that investors are likely to concentrate in particular upon 'cash-plus' returns.

We have been preparing for what we expect to be the next phase in bond markets by reducing government duration (and in some places establishing short duration positions versus reference indices). Meanwhile, we continue to invest in emerging markets and corporate bonds to take advantage of the remaining scope for 'spreads' (the additional yield premia over government equivalent issues) to narrow. Our expectations for the coming year warrant our maintaining a similar investment approach, in which interest-rate risk is partially hedged and in which exposure to corporate bonds is intended to deliver much of the strategy's return. We believe that currency allocation will play an important role, supported selectively by rising interest rates, and we continue to favour investment opportunities away from the indebted West.

Bond strategies are likely to struggle to reproduce the returns of 2009 once authorities around the world start to raise interest rates, albeit that we anticipate that rate rises may not occur in major Western economies for another 12 months. Against an uncertain backdrop, and given mounting sovereign risk, bond investors are likely to favour a strategy that can be defensive when necessary, but which will take risks where appropriate.