Key points

• The Fidelity Funds - US Dollar Bond Fund invests principally in US Dollar denominated debt securities
• Investment strategy incorporates 1) active credit and sector selection, 2) asset allocation, duration and yield curve positioning, 3) currency exposure
• Portfolio is cautiously positioned with overweights in deleveraging credits in US industrials and positions in senior debt in financials sector
• Underweight bonds from European peripherals
• Will maintain current 60/40 allocation to high quality corporate bonds and government bonds respectively, which has demonstrated superior risk-return characteristics
• Both USD and SGD-hedged classes available on fundsupermart.com and WISE@fundsupermart.com

We interviewed Fidelity Worldwide Investment to gain a deeper understanding of the Fidelity Funds - US Dollar Bond Fund. While the SGD-hedged class of the fund was only launched in March 2012, the USD strategy has been in place since 1990 and has managed to deliver impressive returns over the years. Its three and five-year annualised returns were 4.0% and 6.7% respectively (as of 9 August, in USD terms with dividends reinvested).

Fundsupermart (FSM): Can you briefly describe the fund’s investment objectives and explain the strategy utilised?

Fidelity Worldwide Investment (FWI): The Fund invests principally in US Dollar denominated debt securities and aims to provide a higher income than a cash / currency fund and the possibility of capital growth while limited the associated risk.

It is currently invested in principally in investment-grade US Dollar denominated bonds i.e. treasuries, government agencies, supranational entities and corporate bonds.

The hallmark investment process of this Fund is its multi-strategy approach, which generates many sources of risk and drivers of potential returns. These include:

• Active credit and sector selection: significant contributors to our funds’ risk and return
• Asset allocation, duration and curve positioning: helps diversify the sources of performance
• Currency exposure: kept neutral for major currency crosses as active positions tend to add volatility but not consistent alpha

These strategies are used in tandem and no one strategy or position is allowed to dominate overall risk profile of the Fund.

This investment process is driven by a team effort led by the portfolio manager and does not rely on the individual style of the portfolio manager. This helps ensure that the Fund has diversified investment positions which work towards generating attractive risk adjusted returns. These positions are identified through Fidelity’s proprietary research process which spans across fundamental credit analysis, quantitative modelling and macro-economic research. As a result, the Fund contains a mixture of top down strategies such as asset allocation, interest rate and curve plays, and bottom up positions on individual names and sectors.

FSM: With its portfolio focused on higher quality debt, how does the fund seek meaningful returns in the current low interest rate environment?

FWI: Given the current market uncertainties, we continue to maintain an overall cautious investment framework. As developed market yields are expected to stay low for some time to come, we believe that high quality carry (carry return is the coupon income return of a bond) and rolldown (when the value of a bond converges to par as maturity approaches) are important to identify and invest in.

In line with our high quality carry and rolldown strategies, we are selectively looking to add high quality credit risk to our existing overweight positions. This includes maintaining overweight positions in the deleveraging credits in the US industrial (non-cyclicals) such as the media and cable, food and beverage sectors. On the financial sector, we have maintained positions in senior debt from US and selective global banks and use long-dated corporate bonds as tactical market timing investments.

We have moved to a neutral nominal duration stance. Additionally, the Portfolio Manager believes that inflation-linked bonds are currently not attractive enough, relative to risks given the benign inflationary environment. As such, we are underweight bonds from European periphery entities.

It is important for investors to bear in mind that a low interest rate environment does not mean that total returns would remain low for the Fund. In fact, the portfolio’s active strategy has contributed to strong capital returns in the Fund, with positive price change contributing to almost 70% of the total returns in the last three years.

FSM: What has been the largest contribution to returns over the last year? (e.g. credit management, duration management, sector rotation etc)

FWI: The major contributor to returns includes the Fund’s overweight duration position and maintaining its curve steepening bias. The Fund also benefitted from its position to high quality corporate bonds.

FSM: The fund appears to benefit during periods of risk aversion due to its focus on USD-denominated securities. Does the fund’s investment strategy change in response to the changing risk appetite of investors?

FWI: The Fund maintains a flexible and nimble approach to investing, adopting an active asset and sector allocation strategy.

The Fund looks to maintain its current 60/40 high quality corporate / government bonds split. In the current uncertain times where liquidity is highly valued, the holding in US Treasuries is a prudent stance.

Typically, this modest “cautiously aggressive” stance has benefitted the portfolio as US treasury yields remain low, whilst corporate fundamentals have remained strong (due, in part, to investors reaching out for yield and into the corporate market. However, should the economic environment shift significantly to the downside, we would be able to quickly liquidate these shorter dated high quality corporate bonds, and move towards a more cautious stance.

The Fund is focused on domestic US securities and has zero to limited currency outside of the US Dollar.

FSM: How does the Fidelity Funds – US Dollar Bond Fund fit into an investor’s portfolio?

FWI: The Fund is a core fixed income holding of US Dollar aggregate bond exposure. It could be viewed as a strategic holding that forms part of a broadly diversified portfolio.

The Fund could be a good risk diversification and store of liquid reserves for clients who have equity-only portfolios which could be beneficial when some draw-downs are required during extreme market conditions.

The Fund is also ideal for strategies focused on capital preservation as most of the investments in the Fund’s investment universe have relatively low volatility.

FSM: The fund has the bulk of its portfolio invested in US Treasuries (46.40% as of 31 May 2012). What are the reasons for the large weight and what are your thoughts on US Treasury yields?

FWI: The Fund’s weighting to Treasuries reflects our bearish outlook on the broader global economy and an environment where liquidity is highly prized. Treasuries are still highly tradable and investors continue to regard them as a “safer haven” than most other major investments.

We expect the yield on Treasuries to stay low as near-term GDP growth of the US economy is likely to be constrained to 1-2%. However, downside risks remain as the “fiscal cliff” issue could become a major impediment to growth. The general de-leveraging trend across corporate America is also likely to weigh on the economy.

On inflation, we believe it is likely to trend lower as we have passed the peaks in the inflation index – wage increases are likely to stay muted and industrial spare capacity remains high. Low inflation expectations are also likely to keep yields low.

Given our view that yields are likely to stay low, we will continue with our bias towards high quality corporate bonds (relative to US Treasuries).

FSM: In light of current market uncertainty, how have you positioned the portfolio?

FWI: We are comfortable with our 60/40 split with a bias towards corporate bonds.

As world governments work to resolve various issues, liquidity remains highly prized and we will maintain our allocation to US Treasuries for this reason.

However, as yields remain low, the allocation to high-quality corporate bonds will offer a good mix risk and return to the Fund. In our credit selection process, we continuously look for positive, deleveraging and bondholder-friendly investment stories that are domestically focused within the US.

In terms of sector, we currently favour the non-cylical industries such as telecommunications, and the food and beverage sectors. While some of these firms are starting to pay dividends and carry out share buybacks (i.e. actions favourable to shareholders), corporate cash balances are still expected to remain healthy.

We maintain a modest overweight position in banks. Many high quality banks have moved past the worst of the non-performing loans since the credit crisis and are now generating reasonably healthy earnings. However, spreads remain wider than other sectors of the corporate issuance market and this is partly because the market is still pricing in the protracted and painful unwinding that took place after the credit crisis. We believe that this sector has yet to rally.

The current low growth environment bodes well for holders of corporate bonds as earnings remain strong. However, we are mindful that investment grade bonds have also rallied significantly and as such, careful credit selection will be vital to adding value to the Fund.

With the Fidelity Funds - US Dollar Bond Fund’s participation in the WISE@fundsupermart.com programme, investors will be able to participate in the fund’s steady growth at 0% sales charge. In conjunction with the launch of WISE, investors with at least SGD 100,000 worth of investments in any of the WISE fixed income funds will automatically participate in our exciting lucky draw. In addition, investors who need any advice with regards to the Fidelity Funds - US Dollar Bond Fund or their portfolios may read more about the fund in its Fund Review or contact our friendly Client Investment Specialist team at advisory@fundsupermart.com.

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