Manager Insight

Tristan Sones ventures far afield for higher yields.
By Michael Ryval | 27/04/17

In December 2015, Tristan Sones, a global bond specialist at Toronto-based AGF Investments Inc., visited Indonesia to see how that country's economy had improved. What he discovered confirmed for him that Indonesia was on a better footing. This led him to conclude that the developing country's supranational bonds, denominated in its local currency, rupiahs, were still suitable for the $672-million AGF Total Return Bond, a go-anywhere fund that invests mainly in developed markets but also holds a sizable portion in emerging-markets debt.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

"In the days of high oil and gas prices, Indonesia took money that could have been earmarked for other things and provided consumers with cheaper energy," says Sones, a 24-year industry veteran who joined AGF in 1993 and has managed AGF Total Return Bond since 2006.

"As energy prices declined, they were able to reduce those subsidies because energy costs were cheaper, and used that money for other projects, such as infrastructure," he says. "It also meant that inflation has fallen in the last few years from an average of about 6% to 3.6%. We've seen some real improvements in the economy."

Sones is attracted to bond issues whose underlying prospects are improving. "If interest rates are falling and inflation is trending downwards, that tends to tick a lot of boxes from a fixed-income standpoint."

Bonds issued in developed countries make up 77% of the global portfolio, and are spread across the U.S., Europe and New Zealand, with a modest Canadian holding. More noteworthy is a substantial 23% in emerging-markets debt. This is comprised of a 16% weighting in sovereign bonds and 7% in corporate credits.

Indonesian bonds, backed by the European Bank for Reconstruction and Development, account for about 2.4% of the fund's holdings. They're only one of 11 emerging-market countries represented in the global portfolio, out of a universe of 75 developing countries ranging from Angola to Zambia. Sones relies on a proprietary model that is updated each month and ranks each country according to three basic areas and then assigns them a score. The ones that score highest make the grade.

"We've always been more fundamentally driven in terms of looking at countries," says Sones. "The model is designed to assess fundamental factors that are important in determining which countries are attractive."

The first part of the exercise, known as Tier One, looks at a number of factors for each country, such as real growth rates, inflation rates, current account and foreign-exchange reserves. There is also a momentum component that shows how economies and inflation rates are trending.

That is, a country may have had a strong growth rate but has recently started to deteriorate. "The momentum component assigns a score for how the Tier One fundamentals are performing," says Sones. Tier Two, which is secondary to the assessment process, looks more at relative value, measuring countries against each other.

"This is not a black box, in terms of if a country scores high we will automatically include it. It just identifies which ones could belong to the portfolio." Indonesia, he adds, scores well on Tier One, and is balanced on the momentum side and Tier Two. "Overall, Indonesia scores at the higher end."

One of the newest countries that have recently made the cut is Argentina. "Tier One and Tier Two are balanced, but it's actually scoring quite well on the momentum side," says Sones. Since Mauricio Macri's election as president in December 2015, his government has taken steps to get Argentina back on track. It achieved lower inflation after currency controls were lifted, and attracted foreign investment. AGF Total Return Bond has a 1% Argentine weighting.

"Yes, Argentina has a history of defaulting," says Sones, referring to the 2001 debacle that saw investors lose billions of dollars. "But in this case, we have taken a lower exposure and we have bought an Argentine bond in a U.S.-dollar-denominated security. It's the first time in my tenure that I've done this." The nine-year bond is yielding about 6%.

Sones, who also manages the $150-million AGF Emerging Markets Bond, notes that 2016 was a banner year for emerging-markets bonds and high-yield bonds, which tend to be lumped into the same category. Moreover, a large part of the returns was capital appreciation. The median fund in the High Yield Fixed Income category, which includes emerging-markets bond funds, returned 9.9%, of which more than half came from capital appreciation.

This is not likely to recur in 2017, says Sones. "But the running yield on these bonds is very attractive relative to what you can buy (in developed markets.) We're not putting 5% or 10% in any single name. But a small measured position, that has a good story behind it, makes a lot of sense in terms of providing a bit of extra income."

Though it returned 7.5% in the 12 months ended March 31, AGF Total Return Bond lagged the median fund in its category. Sones attributes the fund's underperformance to its more diversified and less volatile asset mix.

"It was a great year for high yield. But AGF Total Return is not a pure-play high-yield or emerging-markets fund," he says. "We are a total-return, unconstrained fund in the high-yield category. The 10-year track record provided a return that is close to the category, but our risk rating is below average."

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