e-fundresearch.com: To what extent has the Jupiter Dynamic Bond SICAV been able to benefit from the strong appreciation of the US-Dollar in the second half of 2014?
Ariel Bezalel: The potential impact of a strengthening US dollar on the world economy is a concern. On the one hand, a stronger dollar is disinflationary and could end up doing the heavy lifting for the Federal Reserve in terms of policy tightening and broadly speaking is good for the US consumer and corporate sector. However, estimates suggest that as much as US $5tn has found its way into emerging market economies as a result of Fed policy since the financial crisis, with China receiving as much as $2tn alone. The flow of easy money has meant that these economies have taken on a lot more leverage, at the expense of reform, and investors have become less concerned about risk as they hunt for a decent return on their money. We worry that the unwinding of this carry trade could exacerbate weakness in the developing world and add to the headwinds already faced by China. This may be a key event for 2015.
Traditionally the dollar has an inverse correlation with commodity prices. While cheaper oil is positive for US consumers, it poses a threat to the shale-oil industry which has made a large contribution to US growth in recent years. About 40% of all new jobs created in the US since June 2009 have been in Texas alone. It has also made resources-rich emerging markets look vulnerable. Russia has been the most extreme casualty of this dynamic so far, although geopolitical factors have obviously been a key factor in the country’s current economic woes. There are potential winners in this environment, however. Cheap oil is a big positive for India and could ultimately help Europe, although structural challenges remain in the region.
The Jupiter Dynamic Bond SICAV benefitted particularly in the fourth quarter of 2014 from our decision to take a significant overweight position in the US Dollar versus the Euro. In an environment of heightened risk reduction, this position made a strong positive impact. We believe that US Dollar strength has further to go, although we have scaled back our exposure somewhat, cognisant that this is a very consensus trade and that the recent ECB announcement around QE could provide a short-term boost to sentiment and growth in the Euro area.
e-fundresearch.com: How optimistic is your view into the future and what obstacles and challenges should investors be prepared to overcome in 2015?
Ariel Bezalel: We believe the UK economy may slow in 2015 amid ongoing problems in the eurozone, which is where about half of the UK’s exports currently end up. We are also concerned about policy risk as we head into an election year. Both major UK political parties are making plans to balance the budget at a time when the Bank of England appears to be considering a pull back from its expansionary policies. This could be a double whammy for the private sector and may force Mark Carney to think again about a rate rise in 2015. As a result, sterling could be in for a rough ride, which is a reason why we currently retain exposure to the US dollar.
In our view, fundamentals remain generally sound for credit, although we expect a modest pickup in default rates given interest rates are likely to stay lower for longer. There is a discrepancy between the US and Europe, however. Not only is the former more exposed to interest rate risk than European counterparts, some 15-20% of US junk bonds are associated with the energy sector. The drop in the oil price has therefore made US credit look particularly vulnerable and we would not be surprised to see further outflows from domestic credit funds this year. We continue to favour European high yield bonds where central bank policy remains supportive and companies generally seem more focused on paying down their debts. That said, we are focusing exposure on more defensive sectors and in shorter-duration maturities.