The investment manager that pays no mind to rising rates

David Thornton

Livewire Markets

Rising rates are like the plague for fixed income portfolios. That is, unless you're Ardea. 

When rates go up, so do yields. But when yields rise, the value of bonds decreases. So, if you're holding a collection of bonds, interest rate increases mean the value of the portfolio goes down. 

But Ardea does things a bit differently. 

"We specialise in a type of investing called pure relative value investing," says Gopi Karunakaran, co-CIO at Ardea Investment Management. 

"And that's not at all about having a view on rates or which way rates are going to go or having a view on the bond market or the economy. It's entirely about taking advantage of market inefficiencies."

In this wire, Karunakaran explains how Ardea finds these price discrepancies and turns them into returns, and why today's market is a target-rich environment for this kind of investing. 

 

Edited transcript

LW: How do you manage duration in a rising interest rate environment?

Karunakaran: The short answer to that is we don't need to, and that might sound like a bit of an odd thing for a fixed income manager to say. It comes down to, I guess, the type of approach that we adopt at Ardea being quite different to traditional approaches. So when you think about traditional bond investment approaches, and I am simplifying and generalising a little bit here, but the traditional approach is you accumulate a portfolio of bonds. Those bonds are going to pay you income or yield. In exchange for that return, you're going to be exposed to interest rate duration risk. And the risk there is if you are holding bonds, rates go up, bond prices go down and that's going to have negative performance impact. So that's how the traditional bonds work and that's why duration management matters a lot.

What we do is we use those same government bonds that everybody else uses, but extract returns from them in a very different way. What we specialise in Ardea is a type of investing called pure relative value investing. And that's not at all about having a view on rates or which way rates are going to go or having a view on the bond market or the economy. It's entirely about taking advantage of market inefficiencies. What we really are exposed to is price differentials between similar securities that are closely related, but at the overall portfolio level, we manage the portfolio to be neutral to duration at all times. So really makes no difference to us whether rates go up, down, sideways or whether the bond market goes up or down. 

LW: Can you give us an example of price discrepancies you’ve seen in the relative value space?

The price discrepancies we're seeing in the relative value space are extreme at the moment.

So to give you some context, the level of sort of stress that's evident at the moment in interest rate relative pricing relationships, without exaggeration, is on par with the depths of the 2008 financial crisis. Now that's probably not obvious to most people, because if you look at other spaces in financial markets, yes, they've done badly. I mean, equities are down, credits down. In the bond market, you've had pockets of weakness as well. But none of those things are at anywhere close to the kinds of extremes that we saw back in 2008. Whereas when you look at interest rate relative value, it is very much there. And the reason it's there is because of the extraordinary volatility we've seen in rate markets. Frankly, a lot of people have been burned and a lot of capital has exited the space. So the kinds of pools of capital that would normally step in to try and sort of arbitrage or intermediate away these anomalies has pulled back.

I remember. I was trading these markets right through 2008 and we're hearing a lot of the same kinds of things now where people are basically just saying, "Look, I can't stomach the volatility. I need to get out." And that's creating this enormous opportunity set at the moment.

Learn more

Ardea Investment Management is a specialist fixed income investment manager with a focus on delivering consistent alpha to clients through an investment process supported by a highly intuitive risk system. For further information, please visit their website

Managed Fund
Ardea Real Outcome Fund
Australian Fixed Income

1 fund mentioned

1 contributor mentioned

David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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