Volatility re-emerges as economies decouple
Volatility has recovered from the summer lull, as a variety of markets have started to reprice the underlying economic realities. The most significant is the decoupling between the US/UK and the Eurozone where the fundamental divergence is clearest in the dynamics of the unemployment rates of these two blocs with the US/UK witnessing a significant improvement in labour market conditions, while the situation continues to remain dire in the Eurozone. This economic fragmentation creates significant opportunities from the perspective of directional and relative value trading. All in all, we think that uncertainty is likely to rise further as the above decoupling takes place and this is most likely to manifest itself in a more sustained increase in volatility.Structural trends appearing in the FX space
We believe the ongoing rally in the USD has structural roots. The US economy appears to have decisively shifted course and the relatively strong growth outcomes are now gaining support in FX expectations.In Europe, the structural problems remain increasingly challenging as ever. Nominal growth remains anaemic and inflation is still not reacting to the significant easing done by the ECB. Our view is that this theme will continue to run with frequent corrections in coming years, as the FX valve is used by the ECB to generate both growth and inflation. In addition, with periphery spreads now so narrow, the heavy debt burden against a backdrop of near zero nominal growth is potentially a risk factor waiting to make an entry in coming quarters.
Fundamental differentiation likely to become a more permanent feature in the global asset landscape
Looking at different assets of various countries over the last few months shows that fundamental gravity factors are reasserting themselves strongly once again. For instance, in the EM space, we have seen currency and rates of countries such as India fare much better than their other emerging markets peers. We think such fundamental based opportunities are likely to become a sustained theme in coming months.
Our high conviction ideas
Continued flattening of the US/UK curve remains one of our high conviction structural ideas. Indeed, our fundamental analysis based on the principal component technique has increased our conviction in this theme. As mentioned above, we remain positive on the dollar, though positioning and sharp tightening of US financial conditions raises the risk of a more “confused” Fed. In the EM FX space, differentiation remains our key guiding principle, with countries such as India likely to fare better than CEEMEA countries such as Hungary and China-related risks such as the New Zealand dollar.
Our negative view on credit remains intact and we believe that the injection of volatility will force the markets to reassess the liquidity picture and the sharp fall in dealer inventories remains a negative structural development, which we think will force a higher risk premium in leverage providing asset classes.
Fund philosophy - LOF–Absolute Return Bond
The LO Funds–Absolute Return Bond follows an absolute return approach to fixed income investing. It aims to deliver returns of Cash +4% over a cycle with a volatility target of 5%. The Fund is highly flexible in its approach and has the ability to go long and short interest rates, credit or FX based on the team’s views of the markets.
Our investment strategy combines the macro views of the aggregate investment team and the individual skillset and experience of highly specialized portfolio managers. The Fund therefore features several specialized sub-portfolios in order to efficiently express all investment views and provide a diversification of return sources.
Gregor Macintosh, LOF-Absolute Return Bond
