June 2022 / INVESTMENT INSIGHTS
A Flexible Bond Approach to Help Navigate Volatile Markets
How the T. Rowe Price Funds SICAV–Dynamic Global Bond Fund¹ may help during this challenging environment
Key Insights
- The Dynamic Global Bond Fund delivered a positive return in the first four months of 2022 during an environment of heightened volatility and a heavy sell-off across bond markets.
- Fixed income markets have entered a new regime where volatility is likely to be more persistent due to the withdrawal of central bank liquidity support.
- Investors should think differently about diversification as the stock/bond relationship is showing signs of changing.
1The fund is actively managed, and the manager is not constrained by the fund’s benchmark, which is used for performance comparison purposes only.
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
It has been a tumultuous few months 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 turbulent period is far from over. If anything, it is only just beginning. We have entered a new fixed income regime as markets prepare for life without the support of central banks.
Tough Period for Global Bond Markets
(Fig. 1) Performance breakdown of major bond market segments
As of April 30, 2022. All Index returns are total returns.
Past performance is not a reliable indicator of future performance.
Euro Investment Grade: Bloomberg Global Aggregate Corporate–European Euro Index hedged to USD, Germany Treasury: Bloomberg Global Treasury: Germany Index hedged to USD, U.S. Treasury: Bloomberg U.S. Treasury Index, Global High Yield: Bloomberg Global High Yield Index hedged to USD, EM Local: J.P. Morgan Government Bond Index–Emerging Markets (GBI–EM) Global Diversified, U.S. Investment‑Grade: Bloomberg Global Aggregate Corporate–United States Index hedged to USD.
Sources: Bloomberg and J.P. Morgan Chase & Co.; analysis by T. Rowe Price (see Additional Disclosures).
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, also plan to begin reducing their balance sheets. With quantitative tightening on the horizon, we believe that it’s likely to be a lot faster and larger in scope than ever experienced, especially if multiple global central banks all do it in unison.
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 risk markets, such as credit, are particularly vulnerable as they have not fully priced in the prospect of quantitative tightening even after the recent sell‑off. Therefore, we expect credit spreads to widen further as the market grapples with tighter liquidity conditions, slowing growth, and higher inflation. 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.
We believe that this new regime requires volatility management. In the 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.
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.
What’s Your Hedge?
(Fig. 2) Rolling 252‑day correlation of the S&P 500 to 10‑year U.S. Treasury return
As of March 31, 2022.
Past performance is not a reliable indicator of future performance.
Source: Bloomberg and analysis by T. Rowe Price (See Additional Disclosures).
In the 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.
Why the Dynamic Global Bond Capability?
In the 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 four 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.
Performance Table
(Fig. 3) T. Rowe Price Funds SICAV–Dynamic Global Bond Fund
As of April 30, 2022.
Past performance is not a reliable indicator of future performance.
Figures are calculated in U.S. dollars.
* Source for performance: T. Rowe Price. Fund performance is calculated using the official net asset value with dividends reinvested, if any. The value of the investment will vary and is not guaranteed. It will be affected by changes in the exchange rate between the base currency of the fund and the subscription currency, if different. Sales charges, taxes, and other locally applied costs have not been deducted, and, if applicable, they will reduce the performance figures. Where the base currency of the fund differs from the share class currency, exchange rate movements may affect returns.
† Effective November 2, 2021, the primary benchmark for the T. Rowe Price Funds SICAV–Dynamic Global Bond Fund changed to the ICE BofA U.S. 3‑Month Treasury Bill Index. Prior to this change, the primary benchmark was the 3‑Month USD LIBOR.
‡ Since inception June 10, 2015, through December 31, 2015.
The manager is not constrained by the fund’s benchmark, which is used for performance comparison purposes only.
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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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Arif Husain is the head of Global Fixed Income and chief investment officer of the Fixed Income Division. He is chairman of the Fixed Income Steering Committee and a member of the firm’s Management Committee. Arif is lead portfolio manager for the Global Government Bond High Quality Strategy. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price International Ltd.