Citigroup Asset Management has begun marketing emerging-market debt and global high-yield bond funds to high-net worth investors in Hong Kong and Taiwan as part of a broader effort to encourage clients to allow more tracking error in order to boost returns.
"The main investment theme is a low-interest rate environment," says Peter Wilby, New York-based managing director and CIO for North American fixed income. "The only thing on earth that can deliver a big return now is emerging markets, and that comes with a lot of volatility. So what we do is combine uncorrelated alpha strategies and allocate those against various benchmarks."
YY Ma, managing director responsible for Citi-AM's quant research in New York, says in the past, bond fund managers could take a higher bet on beta (market) risk by being long domestic bonds against a steep yield curve, which provided big returns as long as interest rates declined. But that environment no longer exists. "So in our case we take risks different from market risk," he says. "We look for risks that are often negatively correlated to the benchmark."
The concept is to diversify risks and sources of return. Ma explains, "With low interest rates and tight spreads, each market offers lower risk going forward, which means managers can't find the same returns as they did in the past 20 years. Returns in the next seven to 10 years will be mediocre. That makes taking active risk more important."
He says although such an approach can mean a very high tracking error, as high as 300-400 basis points against the benchmark, this only translates into an alpha risk of 50-150bp. The firm's strategy is to deviate significantly from an underlying benchmark, as much as 75bps on a monthly basis, but to decouple risk from that benchmark. For example, one of the firm's biggest mandates is for a global exposure to nine asset classes benchmarked against cash, with a tactical asset allocation overlay.
"We're big believers in global TAA," says David Torchia, managing director responsible for high-quality US fixed income. "Our asset allocation team has worked together for 15 years."
The team's basic market view is that real interest rates are below historic averages. Over the past 40 years, average real inflation has been 2.75%, but today's low inflation is more similar to the period of the 1950s and 1960s, when real inflation averaged 1.75%. This period of low interest rates and low inflation lasted until the 1970s when central banks lost credibility, says Wilby.
Today, Citi-AM believes the US Federal Reserve Bank remains committed to fighting inflation, and that central banks worldwide have credibility and need mainly to avoid interest-rate spikes. Although US rates are going up, Citi expects the 10-year Treasury to reach 4.75%, maybe 5.0%, by the end of this year, up from the current 4.25%. "US economic growth looks like it's in good shape but it's dependent on the sustainability of a global low-interest rate environment," Wilby says.
Inflation is gently rising but not unlikely to spike upwards, he argues, given the openness of global markets and the ruthless price competition across industries because of Asia's economic integration. "Of 35 industry groups in the US, only five still have pricing power," he says.
The firm is sanguine about a dollar crisis. Citi-AM doesn't see a hard link between America's budget and current account deficits. Spending constraints in the second Bush administration will start to move the US budget deficit from 3.5% of GDP towards 2.6%, while the current account deficit can only be addressed in conjunction with currency adjustments in Asia, Wilby says.
The firm has added an emerging-market debt and a global high-yield fund to its Salomon Brothers Global Horizons series of Dublin-domiciled funds that it is now offering to private clients in Hong Kong, Taiwan and Europe, with a monthly income feature, says Freeman Tsang, vice president and head of local retail sales in Hong Kong.
