Interview: Kevin Maloney, CIO, Gottex

Kevin MaloneyFixed income investors might feel like they are backed into a corner. After months of generally good returns in the higher yield part of the spectrum,there are doubts in some quarters that 2013 will be so kind.

For bond investors that have accepted low returns for a safe haven, warnings about negative real yields must be playing on minds now, especially as pension scheme funding levels remain unmoved over the year.

Meanwhile, for some people equities were signaling a comeback after New Year – a torment for bond investors still scared off from the market since 2008.

Kevin Maloney, chief investment officer at Gottex Fund Management, a Swiss fund of hedge fund company, says it is time for investors in bonds to look at alternative fixed income strategies if they are going to take action in the coming months to deal with inflation and possible interest rate changes that may erode bond returns.

Given that these alternative strategies include long-short, is Maloney surreptitiously suggesting a big short of the asset class?

“That’s too dramatic,” he says. “I would not 100% short bonds.” Maloney does think there is a “bit of bubble” in bond markets, at least if a bubble is defined as people persistently investing in an asset class on the back of recent returns.

As well as long-short, Maloney advocates floating-rate bonds.

“Floating rates take away the effects of rising interest rates. Rising interest rates will reduce capital values of bonds. Increasing capital values from reduced rates have been a significant part of total returns in bond markets that is unlikely to be repeated.”

Otherwise, the outlook for traditional bond portfolio returns is low, Maloney says.

“Forward looking yields from here are quite low. If you assume rates will not rise or fall, the return you are signing up for is quite anaemic.”

US government bond rates are still sub 2%. The flight to safety into these bonds, though understandable, means investors are giving up purchasing power on a five-year horizon due to low interest rates, Maloney says.

However, Maloney expects central banks to hold rates for a while longer.

Does he expect that some of Gottex’s underlying fixed income managers are shorting US and German bonds, the two main safehavens?

“Some of them will be, but they are also investing long, either in corporates or structured credit, such as mortgage-backed securities, where they can find value. They will be using floating rate instruments so that the interest-rate risk is not part of the structure, or hedging out interest rate increases.”

Gottex is underweight bonds in its asset allocation.

Maloney views equities as reasonably valued assuming growth returns, but “pricey” if corporates “continue to just muddle along.

“Companies can only increase profits by cutting costs for so long. Sooner or later they need top line growth.”

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