Brandywine Asset Management, Wilmington, Del., is well known as a value equity manager. Less well known is that it also offers global fixed-income management.
In fact, Brandywine has $1.35 billion in global fixed income under management. For the seven years the strategy has been offered, it has returned a 9.34% compound annual return. For the past five years, the return was 9.8% compounded annually.
That's a pretty good return when compared with the Salomon Smith Barney World Global Bond index return of 3.1% for the five-year period, and even the Salomon Broad Investment Grade index at 6.4%. Unfortunately, it pales in comparison with the five-year Standard & Poor's return of 17.9% compounded annually.
Needless to say, given the returns of the domestic equity market, global fixed-income management has been a hard sell for the past five years. The returns might seem more attractive now, with the stock market coming off negative returns last year and possibly suffering the same this year.
Stephen Smith, executive vice president, manages the global fixed-income portfolios, and he follows a value approach consistent with Brandywine's approach to equity. He looks for fixed-income investments or currencies around the world that seem undervalued.
Right now, he has overweighted positions in euro-denominated bonds and Australian and New Zealand bonds.
This time last year he had only 8% of the firm's assets under management in euro-denominated bonds. Now it's more than 50%. "As the euro fell, the value of the bonds was greater and greater and greater," Mr. Smith said. Now he believes the dollar is primed for a fall, and that will capture the value of his euro-bond positions. "If the dollar declines by 10% and you are unhedged, you get that 10% plus whatever the coupon is," he said.
Mr. Smith believes the current level of the dollar relative to the euro and many other currencies is unsustainable because of the U.S. account deficit, now running at an annual rate of $425 billion to $430 billion. That's 4.2% of gross domestic product, and it represents a lot of dollars flowing overseas. At some point foreigners won't want to hold that many dollars. Some of those dollars have flowed back into U.S. equities and bonds, but given the decline in the stock market and the drop in U.S. interest rates, the flow back might slow or even halt. That means pressure on the dollar.
The euro bonds might be easy to understand, but Australian and New Zealand bonds? There Mr. Smith has 15% and 7% of his assets under management, respectively. These are significantly overweighted positions.
The reason is he believes the Aussie and New Zealand currencies are significantly undervalued. The Australian dollar is worth just less than 50 cents U.S., while the New Zealand dollar trades at 41 U.S. cents.
Meanwhile, Australian and New Zealand government bonds have coupons of more than 6%.
For the past seven years Mr. Smith's currency judgments have been spot on. Currency decisions provided 51% of the excess return over the benchmark his funds have achieved. Duration and sector decisions accounted for 22% of the excess return, and country decisions, 27%.
Given this record, it's probably not a good idea to bet against Mr. Smith's outlook for the dollar, or the currencies he believes are undervalued.