Legg Mason Global Multi Strategy fund

Legg Mason’s Western Global Multi Strategy fund hit its tenth anniversary in August, with performance highlighting the benefits of fully flexible bond investing. Manager Ian Edmonds says this strategy has actually been running since 1996 – with the fund re-domiciled to Dublin in 2002 – tabling 9% annualised returns in the period since.

In short, the philosophy behind the vehicle is to produce good total returns and a high income by diversifying across the full spectrum of fixed income sectors, countries and currencies. “Our approach is to focus on higher risk/reward parts of the market such as high yield and emerging market debt (EMD), but combine this with better-quality assets – government bonds, mortgages, investment grade paper – to dampen volatility,” adds Edmonds. “Over the market cycle, and some very different conditions in recent years, this strategy has consistently performed well against cash.”

Historical skew

Indicating the fund’s skews, Western uses an in-house benchmark rather than market index, with a quarter each in high yield and dollar-denominated EMD and the remaining 50% in the BC Global Aggregate. This latter index includes the majority of Western sovereign debt and investment grade credit.

Over time, Edmonds says the Global Multi Strategy fund has been around 70% in high yield and EMD to 30% government debt and mortgages. In performance terms, this positioning has generated 9% annualised against 7.5% from the benchmark and 3% from US dollar Libor (cash). Edmonds says Western is a genuinely global business with offices across the world and the fund is a distillation of the group’s best macro and credit ideas.

Looking back over its history, high yield and dollar EMD have always been the major calls but the manager also highlights local currency emerging exposure across countries like Turkey and Brazil in the mid-2000s. “These sovereigns were offering double-digit yields and alongside our other high yield positions, drove strong returns during that period,” says Edmonds. “We continue to see a powerful fundamental case for emerging market debt, with many of these countries converging on Western credit ratings.

In comparison with the over-leveraged West, many emerging countries have less debt, stronger growth, and with lower inflation, more room for policy manouvre.” With debt to GDP levels of around 100% in many Western countries and growth subdued, Edmonds says the developed world’s ability to reduce debt over the short term is minimal.

In contrast, the lower borrowing and stronger growth found in emerging markets creates a much stronger debt servicing profile. “If you look at valuations, US dollar-denominated emerging market debt has an average yield of around 6%, which is in the same region as Italian and Spanish sovereign debt,” adds Edmonds. “These also look attractive compared with BBB-rated US investment grade corporate bonds, which trade on yields closer to 4% and have similar credit ratings to many emerging market countries.”

Moving into 2007, Global Multi Strategy had typically held little investment grade paper – taking its credit risk elsewhere – but added to areas like financials as they sold off throughout the financial crisis. Edmonds says 2008 was a tough year for bonds but the fund rebounded well in 2009, continuing to add investment grade as well rotating EM exposure into hard currency issues. “Our view was that with a weak economic backdrop and inflation falling, emerging countries would let their currencies weaken and dollar exposure in the region remains a key theme for the fund,” he adds.

Current portfolio

Examining the current portfolio, the pro-US and emerging markets and anti-eurozone skew is clear. Edmonds has just under a quarter of the fund in high-yield, with 18% of this in the US and the rest spread across the UK and Europe. “Our bias towards US high yield is mainly driven by our relatively optimistic outlook for US economy while the market also offers greater diversification benefits in terms of more names and industries,” he adds.

“Meanwhile, we have also tactically hedged some of our exposure to European high yield using the iTraxx Crossover Index, anticipating volatility heading into the fourth quarter.” While 12-month default rates for high yield are currently around 2-3%, rating agencies anticipate this moving back towards 5% if we enter recession this year. But with yield spreads over government bonds around 6%, Edmonds says the market has already priced in recession and Western expects defaults to remain below 5% for the next few years. “Another positive is the continued erosion of the maturity wall,” he adds. “At the end of 2009, there was a substantial amount high yield debt maturing up until the end of 2014.

By the end of the first quarter of this year however, the maturity profile of the market was a lot more uniform, with less than $150bn of debt maturing until the end of 2014. Companies have done a good job of using capital markets to extend their maturity profile and are well placed to withstand another recession.” Emerging debt makes up around 30% of the portfolio, with 11% each in dollar-denominated sovereign and corporate paper and the rest across local currency issues in stronger countries in Asia and Latin America as well as Russia. Again, Edmonds has reduced risk in the latter recently, expecting more volatility in emerging market currencies.