Legg Mason Brandywine Global Income Optimiser Fund Q4 Performance Update

Amanda Stitt, Product Specialist at Franklin Templeton gives an update and discusses the outlook for the Fund.

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Transcript

Amanda Stitt:

The fourth quarter began with signs of rebounding global growth tempered by sharply rising COVID-19 cases in many parts of the world. However, fears of a double dip recession were largely extinguished given the news of several highly effective COVID-19 vaccines. This in turn led to optimism for sustained economic recovery in 2021. Now, developed markets central banks concluded their 2020 meetings in December and remained vigilant in their quest to support their economies given the headwinds associated with the pandemic.

The FED kept rates near zero and it was prepared to adjust the stance of monetary policy as appropriate if risks emerged that could impede the attainment of the committee's goals. Now, the ECB introduced a new 500 billion euro stimulus package in December and announced its intention to extend asset purchases to at least the end of March 2022 and to grant more subsidized loans to banks to stimulate lending.

Amanda Stitt:

On the corporate bond side, both the U.S. and European investment grade high yield credit spreads narrowed during the fourth quarter as investor demand was robust given the first phase of COVID-19 vaccinations and risks associated with the pandemic moderated. Spreads in US IG credit tightened to roughly 100 basis points, which was within a few basis points of their January 2020 lows. Credit rating net downgrade actions subsided in the quarter and look set to improve over the coming quarters as credit rating agencies look forward to large scale vaccination programs, increases in fiscal support, and pent-up consumer demand. The global high yield spread also narrowed over the quarter, finishing the period around 375 basis points over treasuries. This translated into a return of 7.5% for the market aggregate, with the lower credit quality buckets outperforming and sectors such as energy performing very strongly due to better global growth expectations and appreciation in the commodity complex.

Amanda Stitt:

Finally, on the currency front, the U.S. dollar decline continued in the fourth quarter, and the greenback ended the year at its lowest levels since April 2018. Two currencies that fell relative to the dollar over Q4 included the British pound and the Japanese yen while emerging market currencies largely rallied. The Legg Mason Brandywine Global Income Optimizer Fund finished the year strongly, returning 5.1% for the fourth quarter (net of fees) and 15.1% for 2020 as a whole (net of fees).

All sub-asset classes were positive contributors to the strategy's performance, with the strongest contribution coming from high yield credit followed by investment grade credit, where we had the most meaningful allocations. Both these sectors continued to rally off the back of better economic data as well as the announcement of multiple COVID-19 vaccines marking a turning point in the world's battle against the pandemic.

Amanda Stitt:

The decision to add small emerging market currency positions towards the end of the quarter funded by a short in the U.S. dollar were contributory to performance as the U.S. dollar broadly sold off. The strategy had maintained some exposure to developed market sovereigns over the quarter, which were a positive to performance albeit a much smaller contribution than credit. Unprecedented monetary policy easing along with expanded fiscal support continues to provide the backdrop for risk assets to continue their upward trajectory.

The team continues to express that view with its large allocation to corporate credit, and as of the 31st of December, the strategy remained heavily tilted towards corporate credit being almost equally tilted between high yield and investment grade. Both of these segments continue to account for approximately 65% of the total portfolio, and across both high yield and investment grade the team believes that credit spreads can continue to compress, especially in areas where that reflation trade is more impactful, areas like consumer cyclicals, basic industries, and energy.

Amanda Stitt:

The quality profile of the Fund continues to reflect our aversion to both tails of the credit spectrum with high holiday offerings, limited total return potential, and lower quality bonds still susceptible to hiccups in the global economic recovery. We also added European high yield during the quarter, which has more direct involvement from the central bank along with low predicted default rates in 2021 relative to the U.S. Rather than purchasing single name credits, we employed a beater overlay in Europe, and that was to isolate the expected spread compression. The team reduced its exposure to developed market sovereign bond duration during the quarter, firstly, by selling about a year of Italian sovereign bond duration as spreads compressed as a result of the ECB buying and the creation of the COVID Relief Fund.

Then, in December, we reduced largely U.S. duration by a further two years, and we believe developed market duration may not provide its historical balance to risk positions during times of minimal stress and the treasury curves should continue to steep them without much interference from the central bank.

Amanda Stitt:

The team continues to reduce it to U.S. dollar position, and as at the 31st of December, the strategy was short 15%. Now, originally, long positions were established in the British pound and the Peruvian new sol funded by that short U.S. dollar position but then the team tilted mostly towards emerging market currencies, currencies like the Mexican peso, the Colombian peso, the Russian ruble, and the Brazilian real. Inflation concerns there continue to be modest overall while commodity prices should recover, which will support currency appreciation across that sector.

While the securitized portion of the portfolio remains consistent at a roughly 10% of the overall allocation, the structure of the underlying holdings has changed. With lower delinquencies and higher home prices, the team became more comfortable investing in lower quality tranches.

Amanda Stitt:

Overall, while valuations are not as compelling as there were during most of 2020, the top-down support by governments and central banks provides the framework where asset prices continue to be supported until the underlying economy recovers. In addition, the technical backdrop in 2021 also looks attractive for credit. Record breaking supply in 2020 should to issuance levels dropping significantly year over year. And meanwhile, demand continues to be strong globally as international investors look for yield opportunities outside of developed market sovereigns. Fundamentally, higher leverage causes some concern. However, companies have built up a war chest of liquidity, and interest rate coverage is not overly stretched.

Amanda Stitt:

Over the course of January and February though, it is possible that the global growth impulse could drop a notch due to that resurgence of social isolation measures in a variety of important countries around the world. However, such measures are unlikely in two anchor economies of the world, and that is the U.S. and China. Moreover, governments in the developed world continue to show no restraint in deficit funding during this time.

Overall, we expect the world economy to be stronger by the end of the year with vaccine success and fresh government stimulus coming from the incoming U.S. administration, as well as Europe, boosting the world economy, which is already on the path to recover.