Legg Mason Brandywine Global Opportunistic Fixed Income 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 a sustained economic recovery in 2021. Developed market 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.

Amanda Stitt:

The Fed kept rates near zero and said 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. 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:

From a yield perspective, the 10-year treasury yield rose, given the positive vaccine use and resolutions of the November presidential election, but outside the US 10-year yields in Germany, the UK, and Japan were largely flat over the quarter. From a monetary policy perspective, the vast majority of developing countries central banks were on hold during the fourth quarter as they continued to monitor economic data and COVID-19 cases before deciding on future actions.

Amanda Stitt:

Among some of the out-performers in the bond markets were bonds issued by Mexico, Malaysia, South Africa, Brazil, and China, and driving this performance was positive vaccine use, rising oil prices amid expectations for improving growth, hopes for less trade disruptions in a weakening US dollar, all of which triggered robust investor risk appetite for higher yielding bonds.

Amanda Stitt:

On the currency front, the US dollar continued over the quarter and the greenback ended the year at its lowest level since April 2018. Two currencies that actually fell relative to the dollar though over the fourth quarter included the British pound and the Japanese yen, while emerging market currencies largely rallied. These included the Mexican peso, the Colombian peso, and the South African rand, but exceptions included the Polish Zloty and the Hungarian Forint which performed poorly due to rising COVID 19 infections in Europe.

Amanda Stitt:

On the corporate bond side, both the US and European investment grade and high yield credit spreads narrowed during the fourth quarter as investor demand was robust, given that first phase of COVID-19 vaccinations and risks associated with the pandemic moderated. The Legg Mason Brandywine Global Opportunistic Fixed Income Fund returned 7.2% over the quarter (net of fees) with its benchmark world government bond index benchmark, which has hedged the Aussie dollar, returned 0.2%.

Amanda Stitt:

This represents an excess return of 7% and it's one of the biggest out-performance periods the Fund has experienced. This strong out-performance was generated by both the bond market positions as well as the currency positions. Within bonds, the biggest contributor was the manager's decision to allocate to US corporate bonds, which strongly outperformed governments and effectively captured market recovery.

Amanda Stitt:

Mexican government bond out-performance was also a strong positive for the strategy, given the sizable overweight. To a lesser extent, positive contributions also came from US treasuries, Brazilian sovereigns, South African sovereigns and Italian government bonds. On the currency side, the biggest contributors were through our short positions in the US dollar, the Euro, and the Yen, and using these currencies to fund our long positions in currencies such as the Mexican, Colombian, and Chilean peso.

Amanda Stitt:

As of the 31st of December 2020, the portfolio remained underweight duration relative to its FTSE World Government Bond Index benchmark and, over the quarter, it had reduced its duration by two and a half years. Duration remains concentrated mainly in Mexico, the US, Australia, and then some select emerging markets. Over the quarter, we removed the exposure to Italian bonds as those spreads narrowed significantly with ECB buying and the creation of the COVID relief fund.

Amanda Stitt:

Now, from a currency perspective we continue to use our shorts in G3 currencies as funding currencies for long exposures to select emerging markets and peripheral European currencies. Over the quarter, the team decided to take advantage of rebounding global growth and expected oil prices, higher oil prices, and established a 3% long exposure to the Norwegian Krone.

Amanda Stitt:

The team also established a 3% long exposure to the Polish Zloty as the team believes the Polish economy is improving and the vaccine should be a plus for future growth. In October, the team introduced a 2% long exposure to the Aussie dollar as the Aussie dollar gains to benefit from global growth improvements, emphasizing the positive signals emerging from China and associated stronger commodity prices.

Amanda Stitt:

Within credit, exposure to investment grade corporate bonds continues to be reduced by the team, and we entered the period with around a 25% allocation. We believe that corporate bond spreads have retreated to more normal levels from the anomalous state that the market had earlier in the year. The remaining exposure continues to be derived from higher quality pro-cyclical names in such areas as oil and gas, autos, industrials, and aerospace.

Amanda Stitt:

Most of the names held continue to be US-based corporates and have strong balance sheets and resilient business model. The team's strategy is to extract what remains of the spread opportunity and hedge out the interest rate risk partially by hedging the portfolio by selling some treasury futures against those credit positions. Exposure to high yield within the portfolio remains consistent at around 3%.

Amanda Stitt:

The introduction of COVID-19 vaccines marked a turning point in the world's battle against the pandemic. While it will take time for the rollout to occur and be effective, this has clearly boosted investor sentiment. Meanwhile, in our view, the twin deficits in the US will continue to grow while the need for fiscal austerity may be needed in the medium to longer term. Elsewhere, we expect a downward trend for the US dollar to continue as its status as a safe haven currency becomes less of a factor in a post COVID-19 world.

Amanda Stitt:

The introduction of the vaccine has buoyed investor sentiment, not only in the US but in Europe, although rising virus cases will be a near term headwind for that region's recovery. From an emerging market perspective, they should also be a long-term beneficiary of improving global growth and potentially rising commodity prices as the impact from COVID-19 diminishes. We are also encouraged that many developing countries have implemented their own fiscal and monetary remedies.

Amanda Stitt:

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

Amanda Stitt:

Overall, we expect the world economy to be stronger by the end of this year, with vaccine success and fresh government stimulus from the incoming US administration and Europe to boost a world economy already recovering strongly.