Fixed Income Interview Question

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40   |   Investment Week   |   28 June 2010                                                                                                

Paul Brain, the head of fixed
income at Newton Investment
Management, explains how
his team has negotiated
market turbulence, with three
out of its six themes playing
out over a rough period for
fixed income managers

  By David      To keep your head while
                the markets about you are
                losing theirs, it helps to
have a reliable map to guide you.
   Paul Brain, Newton Investment Man-
agement’s head of fixed income, says his
team has been aided in navigating this
year’s turbulence by the macro themes
at Newton that guide its understanding
of the world.
   As at least three of its six themes have
played out – the ride has been as rough
as it gets for fixed income managers.
   Since February, Spanish and Greek
debt has been dubbed ‘junk’, blue-
chip UK credit became safer than gilts
and the IMF helped provide a 750bn
(£623bn) rescue package for belea-
guered EU nations. Germany banned
naked short-selling of sovereign debt,
and many practitioners expect Greece
will default.
   Corporate and sovereign spreads
throughout Europe have widened and
narrowed, sometimes on rumour alone.

The big picture
The themes underlying all this form a         L-R: Jonathan Day, Parmeshwar Chadha,
sort of compass Newton managers can           Carl Shepherd, Scott Freedman, Howard
refer to through thick and thin. As Brain     Cunningham, Paul Brain
explains: “They provide a long-term
orientation – a big picture that avoids a
short-term focus.”
   This stands Newton in contrast to
many bottom-up managers, where the
                                                                                                                                         PAUL BRAIN CV
big picture is overshadowed, if not for-
gone totally in favour of pure security                                                                                                   ● 2004 to present: Newton Investment
selection.                                       Newton’s self-explanatory topic of        some point this year, supply will over-        Management.
   Brain says: “We do not pretend to          ‘More Government’ ties into Western          come demand and Japanese bond yields           ● 2001 – 2004: MSG & Partners, chief
cover everything, and we do not suggest       politicians taking over banks, organ-        will rise,” Brain says.                        investment officer, fixed income.
we can analyse everything, but using          ising bailouts and generally becoming          It is not the first time he and his long-    ● 1995 – 2001: Investec Asset Management,
the themes we can start at a very early       more involved in their citizens’ financial   standing team members, have seen such          formerly Guinness Flight.
stage in the process to see where we          affairs.                                     themes evolve.                                 ● 1991 – 1995: Credit Suisse Asset
expect opportunities.”                                                                       All but one of the seven in Brain’s unit     Management – head of currency overlay and
   Under its ‘Becalmed’ theme, Newton         Population dynamics                          has been investing generally for seven         European fixed income.
foresaw investors would hunt for yield,       A further theme of ‘Population               or more years, and for at least three          ● Has 24 years’ experience in managing
but their search would be “a house of         Dynamics’ is widely expected to make         years at Newton.                               fixed income portfolios. His early career was
cards”.                                       its effects felt in Japan, where an ageing     Brain has 25 years of investing expe-        spent investing in high grade bonds with Credit
   As complex debt instruments began                                                                                                      Suisse and Baring Asset Management. He sits
to fail, this house of cards collapsed                                                                                                    on various committees at Newton and is leader
                                                                                                                                          of the fixed income team.
in 2008 and 2009. Muted rates and
inflation have been the painful hangover      “We do not pretend to cover everything, and we do not suggest we
of the pre-crisis debt binge – what                                                                                                      offshore and segregated mandates
Newton calls its ‘All Change’ theme.
                                              can analyse everything, but using the themes we can start at a very                        for larger clients. They also provide
   The unwinding was sharper                  early stage in the process to see where we expect opportunities”                           fixed income input to Newton’s multi-
and more extensive than Newton                                                                                                           asset funds.
had expected. Brain says his team                                                                                                           Brain emphasises the collegiate cli-
“instantly bought treasuries and bunds                                                                                                   mate his employer fosters – one he
and sold credit wherever possible” on         population will turn the savings rate        rience, followed closely by Howard Cun-       clearly enjoys, sharing ideas within and
seeing it unfold.                             negative.                                    ningham with 21 years.                        between disciplines.
   The equity teams also offloaded              “This faces Japanese government               Together, the unit runs £1.5bn in             “In 2007 and 2008, our fixed income
banks while taking a defensive stance.        bonds with a potentially severe gap. At      seven retail funds and £1.6bn more in         credit analysts, Howard Cunningham                                                                                                                                                                  Investment Week     |   28 June 2010     | 41
                                                                                                                                                                                           THE BIG INTERVIEW

and Parmeshwar Chadha, talked exten-                                    also been able to do more work on gilt
sively with the bank analysts about the                                 and government bond mandates, and
credit crisis, for example,” he says.                                   move away from credit, Brain says.
   “There is no need to defend your posi-                                  Manager Jonathan Day’s duties have
tion or job – no-one will stick the knife                               expanded from concentrating on credit
in because of a wrong call, which means                                 to encompass global fixed income, and
you can discuss an example and thrash                                   forecasting and modelling how much
out ideas.                                                              has already been priced into securities.

                                                                                                                                         INVESTMENT MANAGEMENT
   “I have worked in other organisations                                   Parmeshwar Chadha runs New-
where you dare not question a decision                                  ton’s £50.4m Global High Yield Bond
because of house policy or people feeling                               strategy, and analyses high yield issues
personally threatened.”                                                 for the team.
   But he quickly adds, when it comes to                                   Carl Shepherd specialises in emerging
                                                                                                                                         Paul Brain has 24 years’ experience managing fixed income portfolios.
actual investing, the buck stops with the                               market debt and cash funds, while Scott                          His early career was spent investing in high grade bonds with Credit
fund managers.                                                          Freedman joined Newton this year as an                           Suisse and Baring Asset Management. He sits on various committees at
   “There is a danger of becoming a talk                                investment grade analyst, and Trevor
shop, but we ensure you have a manager                                  Holder writes reports and communicates
                                                                                                                                         Newton and is leader of the fixed income team.
for the team, and for each fund,” he says.                              with clients.
   “We do not have a committee-based                                       Brain runs the £741m International                            Manager biography
approach to actual decision making. We                                  Bond, £298m Global Dynamic and                                   2004 to present: Newton Investment Management
believe if you have experienced fund                                    £7.3m BNY Mellon Sterling Bond strat-                            2001 – 2004: MSG & Partners, chief investment officer, fixed income
managers, you give them every resource                                  egies, and is hunting for an additional                          1995 – 2001: Investec Asset Management, formerly Guinness Flight
to come up with the right decisions.                                    investment grade financial analyst.                              1991 – 1995: Credit Suisse Asset Management – head of currency overlay and European fixed
   “A committee takes a lot of time                                        The team shuns the ‘alphabet soup’                            income
coming to decisions, which tend to get                                  of acronyms such as CDOs, CLOs, and                              Responsibilities at Newton: Investment leader, fixed income; chairman of bond / FX strategy
watered down and be delayed.”                                           RMBSs that wreaked havoc as they                                 group; member of macro strategy group; member of asset class strategy group; member of global
   When questioned on how they viewed                                   imploded during the crunch.                                      investment meeting; member of investment committee
the fixed income line-up at Newton,                                        “I will not fund them, nor use complex                        Qualifications: Stage II Candidate – Chartered Institute of Bankers.
multi-managers say they appreciate its                                  derivatives. When we invest in govern-                           able to apply the themes quickly where              “We still lean towards strategic
experience and disciplined process. But                                 ment bonds, for example, we will just buy                        possible,” Brain explains.                       investing rather than trading, and I
some expressed initial concern after the                                them, or vanilla exchange-traded deriva-                                                                          would rather be in the markets for stra-
departure in December 2008 of Stewart                                   tives to track the risk,” Brain says.                                                                             tegic reasons rather than to trade. I
Cowley, Brain’s predecessor.                                                                                                                                                              would rather concentrate my interest-
   Brain joined Newton in 2004 to work                                                                                                                                                    rate risk in something that is more
with Cowley on global bond funds and                                                                                                                                                      liquid, and we have been shifting back
to launch the flagship Global Dynamic                                                                                                                                                     into more liquid markets.
product.                                                                                                                                                                                     “The next phase that could alter
   Cowley’s departure for Old Mutual                                                                                                                                                      things is a rising interest-rate phase like
Asset Managers was a blow for Newton,                                                                                                                                                     early in 1994. Less liquid investments
and a few fund of funds managers said                                                                                                                                                     will suffer, but I think that is next year’s
initially it was unclear who would do                                                                                                                                                     problem rather than this year’s.”
the various tasks on the team. But                                                                                                                                                           Brain expects a bear market for fixed
no team members have left since, and                                                                                                                                                       income in 2011.
Newton’s funds have retained profile.
   Most rank more highly among their                                                                                                                                                         The process
peers over one year than they do over                                                                                                                                                         Newton’s long-term themes form an
three or five years.                                                                                                                                                                         overarching framework for the fixed
   A composite index of all Newton’s                                                                                                                                                      income team’s thinking.
fixed income products has beaten the                                                                                                                                         For             Brain says: “The top-down part of our
unhedged J.P. Morgan Global Govern-                                                                                                                            example, Newton’s          process is more important than the bottom-
ment Bond dollar index in 12 of the past                                                                                                            global government funds split         up part, so if for example there are 150
14 years, and also this year to 31 March.                                                                                                their allocation simply, about 85% to            banking names, we will only try to cover 25.”
Only 1999 and 2008 were losing years                                                                      The                            advanced countries’ sovereigns, and up to           After calculating a fund’s proportionate
against this benchmark.*                                                                      team is, however,                          15% in developing nations’ government            allocation within asset types, countries,
                                                                                   considering buying insurance                          debt.                                            along the yield curve and among sec-
Professional scope                                                      against securities defaulting, known as                              “These are transparent, pure invest-         tors, the team conducts detailed analysis
While heading the team, Brain has also                                  credit default swaps (CDSs).                                     ments, which we have not tainted with            on individual companies, and whether
pushed his colleagues to extend their                                     “This market continues to evolve and                           credit investments,” Brain says.                 they trade cheaply or not compared to the
professional scope.                                                     may now be more useful as a tool in                                 “We do not want to have 50 different          market.
   “When I took over, I thought there                                   hedging credit risk” says Brain.                                 high yield holdings and CDS holdings. We            “In 2008, you saw just buying a bank’s
were really good skills in the team, and                                                                                                 want to be able to get into markets, but         bond was not the end of the story. You
it was ready to move onwards,” he says.                                 Keeping it simple                                                also to get out. We do not want to have to       have to know the capital structure, the call
   Cunningham, manager of the £69.5m                                    Overall, the trading within the unit is                          spend two or three weeks unravelling the         dates, and whether the loan is variable.
Corporate Bond and the £160m Long                                       kept simple.                                                     strategy.”                                       You really must know about the bond issue
Corporate Bond strategies and the                                          “That is important because there are                             Not surprisingly, market liquidity is also    as well as the company.”
driver of the team’s credit process, has                                lots of opportunities, and we want to be                         at the forefront of Brain’s mind.                   Brain has been increasing the exposure
                                                                                                                                            Many of his peers have bemoaned its           of his Global Dynamic Bond strategy to
Newton Global Dynamic Bond Composite/performance vs benchmark                                                                            near evaporation in primary and secondary        developed market sovereign debt recently,
                                                                                                                                         credit markets recently, leading to higher       trimming its overweight position in credit
   3 Months                                                                                                                              trading costs and a lack of opportunities        to do so.
                                                                                                                                         generally.                                          However, Global Dynamic and Interna-
     1 Year                                                                                                                                 “We are very conscious of liquidity, and      tional Bond have dipped toes in Greek gov-
                                                                                                                                         most of our investments in high yield are        ernment debt periodically as yields spiked
    2 Years                                                                                                                              in frequently traded names. We can get a         this year, as well as in Irish and Italian sov-
                                                                                                                                         price on everything we own, but the real         ereigns. The Greek bond position was sold
    3 Years                                                                          LIBOR +2%
                                                                                                                                         worry is how liquidity could change.”            following the announcement of the ECB
                                                                                     Composite fixed income benchmark                                                                     buy-ins.
       Since                                                                         Global Dynamic Composite                            Strategy                                            His global bond funds now have 7%
   Inception                                                                                                                             Brain says some traders have re-entered          exposure to the Piigs, but have the bulk
                                                                                                                                         markets with dealing teams since the             of their European sovereign exposure to
               0                5                10                15                20                25               30               beginning of 2009. “However, I would             Northern Europe.
               Return (%)
                                                                                                                                         not suggest we are back to normal, even
               As at 31 March 2010 Source: Newton. Performance is stated gross of fees. The impact of management fees can be material.
                                                                                                                                         if we are slowly getting there.                  * Source: Newton

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