Sylvain Barrette: What is your focus at Flossbach von Storch?

Lars Conrad: My role is to communicate our strategies and to update clients and investors. I’m representing our portfolio managers. We have three funds on the fixed income side: bond opportunities; bond defensive, which is a more defensive version of bond opportunities; and global convertible bonds.

We are purely active, not driven by any benchmark. The objective is to generate attractive risk-adjusted returns over time.

What is your overall strategy with your flagship fund?

Our flagship fixed income fund, bond ipportunities, is a flexible global bond fund with €6.5bn in assets under management. We are flexible when it comes to allocation to various currencies, and our focus is on developed markets, the two big blocks being the Eurozone and the US. The greatest allocation is to the Eurozone through investments in government bonds, supra-agencies, covered bonds and corporates.

Then we take an opportunistic approach towards other developed markets, which can be Scandies, Swiss franc and UK markets. We also look ‘down under’--Australia and New Zealand--where we find opportunities to diversify from US Treasuries.

How are the US economic developments affecting your business?

We were a bit surprised by recent the rally in US Treasuries--from 4.80% in January to 4.21 currently--on the one hand, and the recent sell-off in [German] bunds on the other. The yield differential tightened by 70 to 80 basis points within weeks, which took us a bit by surprise. We are moderately offensive with our duration stance overall.

Given the recent strong sell-off in German bunds, and the tightening yield differential, it makes bunds more attractive in relative terms.

The consensus, at least from the Fed, is for two rate cuts by year-end. What is your expectation coming from the Fed?

We don’t have explicit forecasts for Fed rates. We don’t diverge significantly from what’s priced in by markets and from the FOMC dot plot. But we are seeing more divergence even from Fed members or Fed speakers.

Do you think that we could see some revision of the dot plot before year end?

We see that the uncertainty as even larger compared to weeks or months ago. We’ve also seen stagflation elements in the latest [Fed] projections. Growth forecasts have been revised down, while the core inflation has been revised upwards, translating into even higher uncertainty.

When it comes to the curve, we are focused pretty much on the belly [5-10 years). We are cautious when it comes to the long end due to debt dynamics and the uncertainty given the rising sovereign debt across developed economies. It’s not only a topic for the US. In the short end of the curve, we are neutral to fairly priced.

Seeing rising debt limits due and rising interest rate expenses is a topic that is here to stay, arguing for a higher term premium for the long end of the curve.

We don’t have targets for central bank rates or for 10-year bonds. We want to maintain the flexibility to adjust to changing market conditions.

What is your expectation when it comes to yield curve development in Europe?

The focus is also on the belly of the curve, 5-10 years.

On 5 March, when we had the initial announcement by the potentially new incoming Chancellor, Mertz, for a new fiscal package, bond yields spiked up more than the 30 basis points in one day. It was the single biggest move since the German reunification in 1990. In the aftermath, we saw the [10-year bunds] peaking at 2.94% before retracing back to 2.77%, the current level.

Before the covid pandemic, we saw negative real yields in the Eurozone, on average, at -0.5%. Then during the covid pandemic, with the fiscal and monetary stimulus, real yields went further down to -1.5%. Now we’re trading in positive territory [with real yields] above 0.5%, moving towards even the 1% levels, which is quite high by historical standards.

Of course, we’re seeing some tectonic changes with the new stimulus and the new debt. But there are many question marks and uncertainty with regards to the exact timing and extent of the new package and its eventual debt supply. The political willingness is there, but over time, it remains to be seen what they will do and to what extent they will utilise the large amounts in question.

It sounds like your playground is up to 10 years, as you seem to stay away from the long end of the curve because they may hit the fan at some point. It’s just that you don’t know when. Fair reading?

We are cautious on the long end, but we don’t want to, let’s say, exclude or give up any opportunities that may arise.

When we invest in the long end, we prefer inflation-linked bonds or solid corporate names, giving us a credit spread and some cushion. [Contrary to sovereigns], you would have this scarcity for high-quality corporates on a relative bond supply basis.

If we do not want to take the duration risk on the curve, we hedge the interest rate risk with the interest rate swaps

Which other European sovereigns do you consider as cheap from a risk-return perspective?

There are no explicit picks standing out.

What about the big elephant in the room: Italy?

We’re trading at historically low levels [re: Italian spread over bunds], and even through levels when we had an active central bank support, [i.e.] the European Central Bank. Given that this large buyer is not active anymore, we don’t see a compelling risk-reward profile [for Italian government bonds].

As a German investor in corporate bonds, what is your opinion on the German OEMs as an investment opportunity?

We are trading all corporates from a technical and opportunistic point of view, and as such we have a high tilt towards higher-rated and high-quality paper within our portfolio. We only have a small fraction in triple B paper within our portfolio. When it comes to automotive as a sector, we’re trading them from a technical basis.

What is rationale to invest ‘down under’?

The third block, Australia and New Zealand, have a portfolio duration of about a bit less than 10%--a good way to diversify from US treasuries. They offer similarly attractive nominal yields compared to US treasuries.

Australia and New Zealand have cheaper hedging costs [than for US treasuries] due to the steepness of the curves, i.e. lower front-end yields. Besides, we do not have US fiscal concerns. For the US, we were talking about debt-to-GDP levels trending towards 120%, while in Australia and New Zealand they are at 40%.

We are also positioned in the belly of the curve, with Australia offering 4.40% in the 10-year and 4.60% for New Zealand against 4.20% for the US.