High inflation and rising interest rates have been making headline news for the past year. Inflation occurs for several reasons, but it doesn’t necessarily happen in every country to the same degree or at the same time. In 2022, while the US Federal Reserve and central banks worldwide began aggressively increasing interest rates to fight inflation, some countries saw more varied rates and conditions.
For more than a decade, APFC’s internally managed Global Rates portfolio has provided an opportunity for the Permanent Fund to participate in fixed income markets outside of the US with the intention of adding global diversification and interest rate protection to the total Permanent Fund portfolio.
Macro view of fundamentals
Making successful global fixed income investments requires significant attention to world events and direct access to world markets. Experience and skill are necessary to understand how each component of a country’s economy will affect its future growth possibilities and how to use that information to make prudent investment decisions. Looking at data including labor, interest, and production rates, APFC’s Global Rates team conducts extensive research to identify which markets have the most potential to generate a positive excess return over the long term.
Sovereign bonds are evaluated on several factors, including APFC’s outlook on inflation, the actions of a country’s central bank, the creditworthiness of a nation, and the shape of its yield curve. The yield curve helps investors understand what a country’s economy might look like and helps inform investment decisions on buying or selling shorter or longer-duration bonds.
“Because we’re looking at the whole world, not just the US market, Global Rates has a greater opportunity to diversify. Every one of these countries has a unique yield curve. Every market has different liquidity, term premium, and credit premium,” says Masha Skuratovskaya, APFC Global Rates Senior Portfolio Manager. “Honestly, the most frustrating thing is knowing that we’re not able to capture everything and might miss an opportunity.”
Investing in global bond markets worldwide makes sense geographically from APFC’s office in Juneau, Alaska. APFC’s trading desk is strategically offset 4 hours from New York and participates in European markets early in the trading day and Australia, New Zealand, and Asian markets in the late afternoon.
Hedging risks to safeguard investments
With bonds, prices and yields always move inversely; if yields go down, the price goes up. APFC’s Global Rates team typically looks for higher-yielding bonds with greater return potential from price gains and yield earnings. Alternatively, they may also be interested in a foreign bond with a similar yield but a higher rating than a US Treasury bond. The bond will pose a lower risk in that case, making it a more attractive investment.
To safely participate in global markets, it’s essential to eliminate specific risks to ensure that only targeted risks will influence an investment’s potential. As such, each global bond purchase or sale involves a complex process that effectively eliminates the risk from exposure to changes in foreign currency value relative to US Dollar, ie Foreign Exchange or FX risk.
“We don’t have to worry about a currency changing in value, but we do have to consider whether the yields on the bonds will go up and down,” says Colton Scrudder, APFC Global Rates Analyst. “We look at macroeconomic factors similar to those you might look for in the US, like core inflation and job markets, to understand the direction in which their rates will move.”
After evaluating the fundamentals and deciding which countries’ sovereign debt to buy, the team reviews which maturities are available and which offer the most advantage. Generally, an investor needs to be paid for the risk of holding an investment over a longer term, so the bond should offer a term premium. Liquidity is also important, since longer-duration bonds in some foreign markets do not trade frequently. Even considering the liquidity risk, these bonds may provide a better return in exchange for the possibility of having difficulties selling them later.
Making up 15% of the Permanent Fund’s Fixed Income asset class, the Global Rates portfolio holds approximately 200 bonds from nearly 50 countries in more than 30 currencies.
“APFC’s fixed income portfolio is a critical building block in the overall Fund portfolio, in terms of liquidity, income generation, consistent yield, and downside protection,” says Marcus Frampton, APFC CIO. “The fixed income team’s ability to execute globally greatly enhances these features, as we are able to find opportunities in a range of different markets that exhibit the desired characteristics to differing, and often greater degrees.”
Masha joined APFC to establish the Global Rates portfolio 11 years ago. Simultaneously the Corporation has built up the internal Trade Operations unit and support infrastructure, enabling APFC to become a more sophisticated investment institution.
In the early days, global fixed income investments were focused on just four currencies. The portfolio has since grown to more than $2 billion, comprised of assets in more than 27 currencies, and they continue adding assets from new countries nearly every year. Some of the more interesting changes in recent years include investments in countries like South Korea, Malaysia, Thailand, and Indonesia which were formerly considered emerging markets but have since crossed over into the territory of developed markets. These investments offer similar or better credit ratings than some Eurozone investments, with more attractive yields.
“Alaskans can be proud of the fact that from Juneau, Alaska, we can participate directly, hedge, and source bonds in many countries and currencies.” Says Masha, “Through the Global Rates portfolio, APFC can provide smoother returns and stability to Alaska.”