Fund outperforms despite challenging interest-rate backdrop

Putnam Investments, 04/21/21


Q1 2021 Putnam Global Income Trust Q&A

  • Longer-term interest rates rose substantially and on a global basis in February and March, contributing to an uptick in market volatility.
  • Active currency positioning helped the fund outpace its benchmark. Interest-rate and yield-curve positioning detracted.
  • Expectations for a stronger U.S. economic recovery have sparked investor optimism and inflation risk.

How did the fund perform for the three months ended March 31, 2021?

The fund’s class Y shares returned –2.97%, outpacing the –4.46% result of the benchmark BBG Barclays Global Aggregate Bond Index.

What was the market environment like during the first quarter of 2021?

Encouraging vaccine news bolstered investor optimism about the strength of the economic recovery in 2021. A $1.9 trillion Covid-19 aid package signed into law by President Biden in early March provided a further boost to market sentiment. Rising prices for stocks and commodities also helped lift the overall market environment. However, concerns about the potential inflationary impact of additional stimulus on top of an already-recovering economy led to an exodus from government bonds. This drove longer-term interest rates higher and placed a degree of pressure on the credit market. After beginning 2021 at 0.91%, the yield on the benchmark 10-year U.S. Treasury note reached 1.74% by March 31. Similarly, the 30-year Treasury rose from 1.64% to 2.41%. Outside the United States, rates moved higher as well.

Within this environment, ascending bond yields weighed on investment-grade debt despite marginal spread tightening. [Spreads are the yield advantage credit-sensitive bonds offer over comparable-maturity U.S. Treasuries. Bond prices rise as yield spreads tighten and decline as spreads widen.] High-yield credit, meanwhile, posted a modest gain, aided by better-than-expected corporate earnings and higher oil prices.

Which holdings and strategies aided the fund’s relative outperformance?

Our active currency strategy added the most value this quarter. This contribution was almost entirely the result of lower-than-benchmark exposure to the Japanese yen and the euro, as both currencies weakened sharply versus the U.S. dollar.

Within our mortgage-credit holdings, commercial mortgage-backed securities [CMBS] provided a further boost to relative performance. Our positions in cash [as opposed to synthetic] CMBS increased in value as spreads tightened.

An overweight allocation to investment-grade [IG] corporate bonds also modestly contributed. IG corporate spreads tightened marginally, resulting in a slight increase in bond prices.

What about detractors?

The fund’s interest-rate and yield-curve positioning was the only material relative detractor in the first quarter. We maintain structural duration positions in the portfolio. Duration has been a very good risk diversifier and normally benefits during risk-off periods when interest rates decline. During the first quarter, however, these positions suffered amid rising interest rates.

What is your near-term outlook?

As the economy reopens amid widespread distribution of Covid-19 vaccines, we believe gross domestic product growth will be robust, particularly in the second and third quarters of 2021. We’re also anticipating a strong recovery in corporate earnings growth. Since growth expectations are already built into asset market pricing, we are cautiously watching the coming months for economic data surprises.

In light of expectations for sturdier growth, we believe U.S. Treasury yields could rise further this year. That said, we think the trend toward higher rates will be more gradual, as bond investors adjust their growth and inflation outlooks, leading to periods of market volatility.

In addition to interest rates and Covid-19 vaccine progress, we will also watch inflation metrics. Given base effects from the prior year and the expected demand surge upon re-opening, we feel the inflation surge will be temporary. However, we have few instances in the past twenty years when both monetary and fiscal policy were aligned strongly toward an easing bias. In Q3, we will be monitoring components of the inflation basket for signs of more enduring impulses that may cause the U.S. Federal Reserve to shift its dovish posture sooner than currently expected.

What are your current views on the various sectors in which the fund invests?

Looking first at corporate credit, we have a positive view of fundamentals and the market’s supply-and-demand backdrop, but are more neutral toward valuation.

From a supply-and-demand standpoint, new issuance of IG corporate bonds in 2020 reached a record level of $1.7 trillion. We think new issuance is likely to decline substantially this year. Given that there is still strong demand due to the lack of yield globally, reduced supply could lift prices for existing bonds. Overall, we believe reduced bond issuance should be positive for the market’s technical backdrop.

It appears that a significant amount of anticipated good news has been priced in by the market. As of period end, IG corporate spreads had tightened considerably, making valuations in this sector less attractive. Consequently, security selection and sector rotation will be of utmost importance as we navigate this market. Additionally, given the increase in interest rates for the United States, IG corporate debt is more attractive to non-U.S. investors.

Within the CMBS market, while there continues to be a degree of negative sentiment toward certain property types, the availability of Covid-19 vaccines has sparked optimism that social-distancing measures could be meaningfully eased by the middle of 2021. As a result, we continue to have conviction in the fund’s CMBX exposure. [CMBX is a group of tradeable indexes that each reference a basket of 25 CMBS issued in a particular year.] We believe current valuations fairly compensate investors for existing risk levels and provide an attractive risk premium.

Fundamental credit analysis and security selection are particularly important in the current CMBS market environment. While some parts of the CMBS market will likely continue to struggle, there are CMBS backed by what we consider to be strong underlying collateral that have suffered amid widespread fear of the sector. We think many of these bonds represent attractive investment opportunities.

Within residential mortgage credit, against the backdrop of robust home sales and a rebound in mortgage originations, we continue to find value across numerous market segments.

In prepayment-sensitive areas of the market, we continue to find value in agency IO collateralized mortgage obligations, as well as inverse IOs backed by jumbo loans and more seasoned collateral. Overall, we view prepayment-related opportunities as attractive sources of diversification for the fund.

As for non-U.S. sovereign debt in both developed and emerging markets, we think the economic recovery will be strongest in countries with large service sectors and effective vaccine distribution. We also prefer countries that can contain government expenditures despite political pressures to raise them.