JP Morgan Fleming is considering a number of changes to its fixed income products that will allow it...
JP Morgan Fleming is considering a number of changes to its fixed income products that will allow it to continue making money when bond prices begin to fall.
Bond investors have done very well in recent years, with yields sinking to lows last seen in the 1960s but many are concerned that prices are at a peak and bond investments will soon start to go backward.
JPMF has two ideas to address the problem ' a new fund of floating-rate notes (FRNs) and an increased derivatives capability on all its bond funds that will allow it to gain negative exposure to fixed interest.
Portfolio manager at the group David Gibbon said clients want to increase exposure to liquidity products and higher-yielding short-duration products.
'There's lots of demand in the market for higher-yielding, cash-like alternatives, and Libor-based products and FRNs that carry some credit risk or other types of risk that offer higher yield are attractive,' Gibbon said.
Unlike conventional bonds, FRNs do not have a fixed coupon rate that applies over the life of the security. Rather, the coupon rate is periodically reset at a yield spread to Libor.
'It insulates you from rising rate environments by adjusting your coupon to make it a market-rate coupon at all times,' Gibbon said.
'Floaters aren't risk-free. They still have a credit-risk component but you have more or less eliminated your exposure to rising interest rates.'
While the FRN market is fairly shallow in the UK and the outlook for issuance is uncertain, Gibbon said JPMF's ability to use interest rate and cross-currency swaps means it can construct synthetic FRN exposure.
The fund could be launched as early as the first half of 2003.
The firm is also looking to enhance the derivatives capability of its existing bond funds. Allowing the group to buy derivative protection against issuers it didn't like would give JPMF an edge over long-only funds.
Gibbon said: 'We have been unable to establish a negative exposure to individual corporate issuers using conventional means ' derivatives will hopefully open that up for us.
'We already use interest rate and bond futures pretty extensively, as well as plain-vanilla currency derivatives, forwards and futures and the like. But we want more functionality in things like interest rate swaps, cross-currency swaps, total rate of return swaps, credit default swaps and options on a full range of instruments ranging from government bonds to non-government bonds to mortgages, corporates and so on.'
JPMF has been looking at systems tools, valuation tools and trade processing tools that it can import rather than developing in-house.
While Gibbon said the move hasn't been prompted by the level of bond prices, he conceded it is useful in a falling market.
'It is made particularly important at this point in the cycle, although this sort of capability will help us out at all points in the cycle, not just at the potential low in yields,' he said.
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