Bond yield volatility has hedge fund managers changing strategies

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Old-school bond investors are showing that it’s not just the fast-money crowd who can thrive in this volatile new era.

Long a staid, reliable place where money managers parked retirement savings, government bonds are now among the most unpredictable in the investment world. Hedge funds have been quick to embrace the volatility — and profits — and now traditional fixed-income players are starting to do the same.

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“As an investor, we have to deal with calming our clients down, but volatility can be our friend,” said Gershon Distenfeld, who manages around US$47 billion as director of income strategies at AllianceBernstein AB.

Bond volatility has consistently overshot other assets for the past two years while long-term yields swing more violently than the daily average of the past decade. That means that buy-and-hold investors have had to morph into traders or risk being left behind in the melee of a fast-paced market.

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For a glimpse into the tricky calculus behind bond market calls, just take last week: producer prices rose by more than projected, but consumer price inflation cooled. That left bets on a United States Federal Reserve rate cut this year in play, and also kept bond volatility alive.

“It’s more of a trader’s market now,” said Tim Magnusson, chief investment officer at Garda Capital Partners LP, a hedge fund. “It’s all been a bit of a transition that fixed-income folks have had to endure and get used to.”

Magnusson said the risk of holding directional bets overnight or over the weekend is higher, with data surprises packing a bigger punch. Distenfeld at AllianceBernstein adjusts his duration, a measure of interest rate sensitivity, more often than the firm typically has over the past 15 years.

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Three-month implied volatility on the US$47-billion iShares 20+ Year Treasury Bond ETF has averaged about 2.5 percentage points in the past year, above that of the US$520-billion SPDR S&P 500 ETF and a reversal of historical trends. Since April, rates on 30-year Treasuries have swung by around eight basis points per day, well above the daily range seen over the last decade.

‘Much more active’

As yields and prices whipsaw, investors just holding an index of Treasuries lost about two per cent this year. By contrast, fast-money quant funds with a large share of trades in fixed income are up 5.3 per cent, according to a Barclays PLC index.

That helps explain why asset managers are doing much less holding and much more buying and selling. JPMorgan Chase & Co. research showed bond mutual funds were turning over Treasuries at a ratio 49 per cent higher at the end of April compared with two years earlier. A similar trend can be seen for German bunds and Japanese government bonds.

“We have to be much more active in management, quicker to add, cut or modify positioning on the curve,” Vincent Mortier, chief investment officer at Amundi SA, said.

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Faster turnover can also be seen on Wall Street, where bond dealers handling the frenetic pace of trading are expecting fatter bonuses. On Main Street, money managers trying to win back hundreds of billions of dollars lost to passive index funds tout their ability to trade and time the market.

Even so, actively-managed U.S. bond funds have yet to show 2024 gains: those with assets of more than US$1 billion lost an average of 0.5 per cent this year through May 14, according to data compiled by Bloomberg. Still, they’re outperforming their benchmark, which is down 1.6 per cent over the period.

As with most things in the bond market, the volatility starts and ends with central bankers. Their retreat since 2022 as the bond market’s biggest buyers has ushered in price-sensitive investors who demand bigger payouts to sweep up a glut of supply.

“Volatility is also an opportunity,” said John Madziyire, a portfolio manager at Vanguard Group Inc., which manages US$9.3 trillion. “If you are a long-term investor, it gives you better entry levels to get in.”

Swings in yields are running 50 per cent above pre-2022 levels, according to AlphaSimplex Group LLC’s measure of intraday sovereign rate volatility captured through futures trading. While those swings are welcome by hedge funds such as AlphaSimplex, they’re a problem for the swaths of traditional firms that rely on a mix of 60 per cent stocks and 40 per cent bonds.

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“If you are taking a long-term view, as many investors do, then you have a lot more risk than many expect with bonds,” Kathryn Kaminski, the firm’s chief research strategist, said.

Rather than experiment with fixed-income volatility, some money managers are looking elsewhere for the hedging power they used to get from bonds. JPMorgan Asset Management is replacing bonds with less-liquid but less-volatile private assets. State Street Global Advisors and Aviva Investors Americas LLC are turning to gold.

The return of easier central bank policy may calm volatility, but probably not back to where it was before the onset of higher rates. Financial markets have already moved to price in more tumult, as high-for-longer Fed funds rates, swelling U.S. fiscal deficits and rising geopolitical tensions around the globe all keep volatility elevated.

“Bonds aren’t quite the safe anchor they used to be and the rise in volatility has portfolio implications,” David Kelly, chief global strategist at J.P. Morgan Asset Management, said. “This isn’t your father’s bond market and you have to adjust appropriately.”

With assistance from Sujata Rao, Ye Xie, Sam Potter, Carter Johnson and Gina Turner.

Bloomberg.com

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