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By Eric Jacobson | 06-19-2014 02:00 PM

Eigen: Fixed-Income Markets Are a Compressed Spring

The longer that rates stay near all-time lows in the face of Fed exiting, inflation pressures, and a growing economy, the less it will take to cause a correction, says JPMorgan Strategic Income Opportunities Fund manager Bill Eigen.

Eric Jacobson: Hi, I'm Eric Jacobson with Morningstar. We're here today at the Morningstar Conference with Bill Eigen of JPMorgan Strategic Income Opportunities. Bill, thanks so much for joining us today.

Bill Eigen: Oh, no problem at all, glad to be here.

Jacobson: You run, as I said, JPMorgan Strategic Income Opportunities. We classify it as a non-traditional-bond fund, but essentially it's an unconstrained and absolute-return strategy. You have a bias at this point in terms of valuations. Why don't you tell us what that's about and how it looks in your portfolio.

Eigen: As an absolute return manager. First and foremost you have to move with the opportunity set. So right now, we're at a point in the cycle where the tailwinds in traditional fixed income are now becoming headwinds. You've got the Federal Reserve exiting; you've got the economy actually growing above trend, which every fixed-income investor's worst nightmare. It's good for equities, bad for fixed income. And you do have some inflation pressure starting to show up in the system, and yet you look at rates, not only in the U.S. but globally, and they are still very, very close to the all-time lowest they've ever been.

Most importantly, other areas of the market that typically offer yield premiums are now converging. In other words you have risk premiums in areas of the market like high yield, mortgage-backed securities, investment-grade corporates, emerging-markets debt, very, very close to the all-time lowest they've ever been.

The problem that that creates as you can imagine is when spreads get tighter and tighter rates get lower and lower, correlations pick up, which means you need a very small backup in interest rates to create a lot of losses as people learned last May and June, when just an innocent remark from a Federal Reserve official caused yields at the 10-year point to double. It wasn’t even the economy or inflation then.

I kind of view the rate markets and increasingly other risk markets within fixed income more like a compressed spring: The longer it stays here the less it will take to cause valuations to just normalize and not to be at these very, very tight levels. And as a result, more recently just over the past few months I have gotten my portfolio much, much more defensive. I am leaning more on short positions and what we call alpha-oriented positions which is targeting mainly relative-value trades. And also targeting higher rates down the road from here and doing it very gradually as rates continue to fall. We continue to add to those types of positions while selling down our beta positions which have been very beneficial to us for the last few years.

We don’t want to overstay our welcome. And the time to sell things is when the markets are incredibly liquid because we know how fast that can turn when volatility hits.

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