Q&A Series: Looking for a steady and attractive income stream every month?

T. Rowe Price is an independent investment management firm founded in 1937 focused on helping clients meet their objectives and achieve their long-term financial goals. Today, they manage USD 1.6 trillion assets across a broad range of active equity, fixed income, and multi-asset investment strategies. T. Rowe Price has 924 investment professionals worldwide and their experience of investing through multiple market cycles contributes to an investment strategy which seeks to generate consistent performance for their clients over the long-term.

In the latest edition of our Q&A series, we have invited T. Rowe Price to discuss how they have constructed a diversified portfolio of global bonds. Investors searching for a high-income (~7% annualised distribution yield) solution may want to read on for more information!

1. Would you consider your fund more bottom-up, or top-down?

We believe an investment process that synthesizes top-down macro views with proprietary, fundamental bottom-up research is the key driver of value-added active management. This holistic approach enables us to harness diversified sources of alpha across four separate categories: sector allocation, security selection, active currency positions, and global interest rate management.

Top-down perspectives:

• Through a series of meetings, as well as ongoing monitoring of economic and market events, the team examines sector valuations, economic developments, currencies, and global interest rates. Monthly sector strategy and global interest rate and currency meetings serve as ongoing collaborative opportunities to share investment perspectives across the firm’s fixed income platform as members of the investment staff serve on the working committees for each meeting.
• The team continuously reviews sector allocation targets to identify tactical opportunities or to address fundamental shifts in the market environment.

Bottom-up perspectives:

• This portion of the process is primarily responsible for generating security selection ideas based on our proprietary research and credit rating system.
• Sector teams draw upon the breadth and depth of T. Rowe Price’s global research capabilities that include over 300 portfolio managers, research analysts, traders, and other investment professionals across the Fixed Income and Equity divisions.

Our investment process is broken down into four main steps, described below, where proprietary research and portfolio construction are complemented by environmental, social and governance (ESG) considerations.

The first two steps typically take the form of a debate where macro themes are discussed (according to an agenda set by senior portfolio managers) and analysts have the opportunity to present investment ideas. Analysts are often challenged by portfolio managers at this stage of the investment process and must defend the level of conviction behind each investment opportunity. The portfolio management team drives the final two steps, assessing each position not only on its own merit, but as part of the overall portfolio construction within a disciplined risk-approach framework. For the Diversified Income Bond Fund, the Global Investment team composed of lead portfolio manager Ken Orchard and associate portfolio manager Vincent Chung, along with five other senior portfolio managers, debate and reach consensus on portfolio construction.

2. Global sovereign bonds account for a large part of your portfolio. What key themes should sovereign bond investors pay attention to?

As of 30 June 2024, the portfolio’s over-50% allocation to global sovereigns reflects our current more defensive positioning.

Notably, in the June quarter, we trimmed the portfolio’s exposure to global high yield corporate bonds and securitized credit, while adding to global and emerging markets sovereign debt. We felt valuations looked extended after several months of spread-tightening. Additionally, the scenario where the Federal Reserve keeps rates higher for longer could erode some of the momentum in economic growth and corporate fundamentals. While we maintained a relative risk-on view in credit, we continued to keep exposure to credit risk lower than our historical range given stretched valuations.

That said, due to the flexibility of our investment process and strength of our fundamental research capabilities, we seek to add significant value by tactically allocating across sectors, countries, and currencies, depending on valuations, stage of the economic cycle, and market conditions. Hence, we may choose to underweight global sovereigns and dynamically allocate to credit again when we see better opportunities.

3. How does your fund approach investments in high-yield bonds, compared to those in investment-grade bonds?

We will typically invest no more than 40% of the fund’s net assets in non-investment-grade securities. We seek to maintain an overall portfolio credit quality of investment grade.

Our investment approach for high-yield and investment grade bonds are largely similar. We:

• Utilize the full global opportunity set to seek diversified sources of income and return.
• Invest around the world and up and down capital structures.
• Focus on risk-adjusted returns over a medium-term horizon.
• Tactical allocation across 16 fixed income sectors, 80+ countries and 40+ currencies.
• High conviction security selection from T. Rowe Price Associates’ (TRPA’s) proprietary global research platform.
• Diversify risk by avoiding excessive concentration in any one sector, interest rate cycle or risk factor.

Our corporate analysts, who specialize in specific industries, use rigorous fundamental analysis to assign a proprietary credit rating to all the bonds in our portfolios, which represents a determination of the financial strength of an issuing company and is based on factors similar to those considered by Moody’s or Standard & Poor’s. In addition to internally rating each security, our credit analysts are also responsible for developing a standardized conviction score for each bond in their coverage universe. This score of 1 through 5—with 1 being the highest conviction recommendation and 5 signifying that the manager should avoid entirely—helps promote clarity and consistency across the global credit research teams that support the strategy.

Specific to high yield securities, however, the team eliminates issues with a market value of $200 million or less from the pool of potential portfolio candidates to establish baseline liquidity and suitability. Quantitative fundamental research further narrows the field to around 500 to 600 potentially attractive opportunities. At this point, the high yield credit analysts begin in-depth research incorporating both quantitative and qualitative methods.

In addition, investing in non-investment grade securities does expose the fund to greater credit risk, which is the risk that an issuer of a debt security could suffer an adverse change in financial condition that results in a payment default, rating downgrade, or inability to meet a financial obligation. We monitor and manage default risk through stringent fundamental research, portfolio diversification, balanced sector allocation, the use of proprietary and third-party performance attribution tools, and periodic portfolio review by senior investment professionals and our compliance staff. Credit quality and liquidity also matter in terms of position sizing, and lower-quality, higher-volatility and less liquid securities will often have a lower portfolio weighting.

4. What are your fund managers’ views on the interest rate outlook? How would your positioning change if we start seeing the beginning of a Fed rate cut cycle?

Investors continue to expect two or more Federal Reserve rate cuts this year. Although economic indicators in the U.S. are showing signs of slowing, we remain constructive on the U.S. economy. While the market has moved to expect a fair chance of a recession, we think that a recession is less likely with the Fed looking to ease. We believe the Fed will likely begin rate cuts at its September meeting, but the neutral rate in the U.S. may be higher than what the market currently expects.

While we expect yield curves to steepen in the long term, in the shorter term we expect them to flatten. The market has already tried to anticipate quick rate cuts twice in this past year and it’s trying again now. We’re not convinced such a rapid easing cycle is necessary. In the meantime, the long end of the curve is well supported by demand from pension funds and life insurers. Separately, we still believe that credit markets offer the best opportunities right now. However, we’re also aware that there are some significant tail risks out there, such as geopolitics, upcoming elections, potential inflation spikes, and a weakening consumer base. When a market isn’t pricing in much for tail risks, even when they clearly exist, it’s a signal that we need to tread carefully. This is exactly the kind of environment where careful issue selection becomes crucial.

Nonetheless, even though we don’t agree with how quickly the market is pricing in rate cuts, the current environment suggests that cash won’t be king forever. We think the global economy may remain strong enough to keep default rates low and long-end rate volatility contained if the Fed begins easing policy later this year. Hence, we would look to incrementally add credit exposure if valuations improve.

5. What is your fund’s track record? How do you ensure your distribution rates are sustainable?

Our dividend policy is not designed to deliberately or systematically pay out of capital. Through our multi-sector approach and active management, we seek to generate total returns that outperform the underlying markets we invest in, producing returns that we can also distribute in the form of dividends. We set the dividend at a rate that we believe is reasonably sustainable over at least 12 months. The basis of the dividend calculation includes the fund’s coupon income, yield to maturity, our market outlook and resulting prospects for both income and capital gains.

In setting the dividend rate, we seek to balance three objectives: a) generate attractive income, b) prudently managing risk, and c) deliver consistency of the dividend. We believe that the dividend payout should be reasonably indicative of the total return prospects of the fund that investors can expect over the medium term. As market yields and spreads can fluctuate over the short term, we will not adjust the portfolio dividend in response to short-term market fluctuations and this may at times result in the fund temporarily paying dividends out of capital. That said, we prioritize maintaining a prudent level of risk over the stability of the payout amount. We will not take excessive risks just to keep the dividend stable, and a significant shift in macro or market conditions might lead us to review our payout and revise the dividend as necessary.

We consider the latest 6.88% annualized dividend yield* as of 31 July 2024 for T. Rowe Price Funds SICAV – Diversified Income Bond Fund Class Ax USD to be reasonably sustainable, barring any major shocks to the global economy. We believe we are in a global secular environment characterized by higher levels of yield and inflation. The drivers of this secular shift are global trends that include a) continued onshoring to build up resilient and redundant supply chains, b) the gradual transition to green energy away from traditional sources, c) reduced immigration globally and d) rising protectionism expressed through tariffs and other barriers to trade. All these are expected to be inflationary and therefore lead to a new regime of structurally higher global government bond yields and tighter monetary policy.

*The fund aims to pay dividend on monthly basis. Dividend is not guaranteed and may be paid out of capital. Annualized Dividend Yield (%) = (Amount per share / Ex-Dividend Date NAV) x 12 x 100. For more dividend information and disclosures, please refer to the Composition of Dividend Payments document on the fund page of our website (https://www.troweprice.com).

Important Information

This material is for informational purposes only and should not be relied upon as financial advice. It does not consider the specific investment objective, financial situation and particular needs of any specific person. Before investing in any T. Rowe Price fund, you may wish to seek advice from a financial adviser or consider carefully if the fund is suitable for you. Nothing in this material constitute an offer, invitation, recommendation or solicitation to buy or sell any securities in any jurisdiction.

Past performance is not a reliable indicator of future performance. Investment involves risk. The value of an investment and any income from it can fall as well as rise. You may get back less than the amounted invested. The performance returns are denominated in the share class dealing currency which can be a foreign currency and if so, US/SG dollar-based investors are exposed to fluctuations in the US/SG dollar/foreign currency exchange rate.

Before deciding to invest in the fund, you should read the offering document/prospectus (including its investment objectives, policies and any risk warnings) and the product highlights sheet which are available and may be obtained from any appointed distributors.

Information and opinions contained in this website are as of the date of publication and are subject to change without notice. While the information is obtained or derived from sources believed to be reliable and current at the date of publication, we cannot guarantee their accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The opinions expressed may also not reflect the opinions of any other T. Rowe Price Group companies.

T. Rowe Price Singapore Pte. Ltd. Is the appointed Singapore representative and agent for service of process in Singapore. SICAV refers to the T. Rowe Price Funds SICAV, a Luxembourg investment company with variable capital which is registered with Commission de Surveillance du Secteur Financier and which qualifies as an undertaking for collective investment in transferable securities (“UCITS”).

Singapore ‐ Issued by T. Rowe Price Singapore Private Ltd. (UEN: 201021137E), 501 Orchard Rd, #10‐02 Wheelock Place, Singapore 238880. T. Rowe Price Singapore Private Ltd. is licensed and regulated by the Monetary Authority of Singapore ("MAS"). This advertisement has not been reviewed by the MAS.