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JPMorgan Global Convertible Income – not as defensive as they’d hoped for

JPMorgan Global Convertible Income Fund has released its interim results for the half-year ended 31 December 2015. During the period, the company’s NAV total return was -3.4% and the share price total return was -7.8%. The company says that whilst NAV performance was stronger than the broader convertibles market, the concurrence of declines in equity markets and the widening of credit spreads meant that the strategy did not exhibit as much of a defensive profile as they would have hoped for.

The managers say that, in the period leading up to the half year end, the deterioration in credit conditions prompted them to increase the diversification within the portfolio. By raising the number of names and reducing the size of the most concentrated positions, the portfolio was repositioned. They say that this avoided some of the sector and security specific problems seen in recent months, yet allowed it to capitalise on opportunities arising from the sell-off in high yielding bonds. The Board believes this to be a sensible compromise, since it enables us to retain exposure to valuations that appear cheap, relative to long term returns, and to credit spreads that arguably exaggerate the risk of recession (especially in the US).

In terms of dividends, one quarterly dividend totalling 1.125 pence per share was declared and paid during the period and a second quarterly dividend of 1.125 pence per share was declared on 23rd February 2016 and will be paid on 31st March 2016. The Board say that it recognises that the pursuit of a dividend at the current level is unduly constraining the manager’s flexibility, given that medium term interest rates have declined since inception. They say that, as a consequence, they have encouraged the manager to focus instead on maximising the total return of the portfolio, but within overall similar risk parameters to the past. That said, the Board does not expect this to impact the dividend, even if, periodically, it requires capital to top up income and will continue to target an annual dividend of 4.5 pence per share for the foreseeable future.

In terms of performance attribution, the managers say that the portfolio’s equity sensitivity, income generation, and positive duration contributed to returns over the period, but these supportive factors were more than offset by weakness in credit factors. The currency hedging of the account detracted value over the period as Sterling generally weakened against other major currencies. However, they say that full-currency hedging does tend to reduce the volatility of convertible portfolios, which are inherently less volatile than equity portfolios.

The portfolio’s exposure to companies in the energy sector represented the largest detractor over the period following renewed commodity price weakness, even though they had used the recovery in early 2015 to reduce the portfolio’s exposure to just 5.6% going into the second half of the year. The managers say that, more encouragingly, the portfolios increased diversification into technology and non-cyclical consumer sectors added value as these were among the only sectors to post a positive return over the period.

In terms of outlook, the managers say that the fact that detrimental credit conditions more than offset the positive impact of a decline in effective interest rates (despite ‘lift-off’) is indicative of the fact that convertibles tend to move more in line with high-yield credit than with investment grade fixed income. Consequently, a scenario in which the US economy improves to the extent that the Federal Reserve feels able to resume rate hikes is likely to represent a more positive outcome for convertibles than an environment in which growth stagnates and duration assets continue to perform. However, they say that economic data has softened and they are looking to position the portfolio to perform in an environment where conditions remain somewhat challenging.

That said, the managers say that they believe that the market weakness going into 2016 has opened up some opportunities within the portfolio, particularly to the extent that they think a large proportion of high yield weakness has been driven by technical factors rather than a significant deterioration in fundamentals. This has reportedly given them comfort in initiating positions in higher yielding securities, although they say that they have done so cautiously. The managers also say that, whilst they remain more cautiously positioned than they were at the time of inception, they do believe that the emergence of significant dislocations into 2016 could provide a fruitful hunting ground over the next 12 months.

JPMorgan Global Convertible Income – not as defensive as they’d hoped for : JGCI

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