Malcolm Jones of Standard Life Investments explains how managers can help investors take advantage of growing fixed income markets.
For many years, fixed income has played a significant role in a well-diversified investment portfolio.
Investors have enjoyed the twin benefits of diversification against the more risky assets in their portfolio and strong returns.
However, consistently positive returns and lower yields over the last 30 years means we are now at the point where it may be harder for yields to fall further.
Indeed, it is not difficult to envisage a future where inflationary pressures brought on by economic stimulus measures from the world’s central banks leads to higher interest rates and increased bond yields.
While rising bond yields are by no means the only future scenario for fixed income investors, it now looks a lot more credible than many would have believed even just a few years ago.
In such a scenario, traditional fixed income investors would have to suffer loss of capital that bond income may not be able to offset.
So, if we are entering a secular period of increasing yields with implications for poor returns from traditional bond investments, now could be the time to explore alternative methods of capturing returns from the opportunities that undoubtedly still exist in the global fixed income market.
One approach we advocate is to invest in fixed income on an absolute return basis.
This approach seeks to provide positive returns for investors irrespective of bond market movements.
Instead of a traditional benchmark index, cash is used as a reference ‘risk-free’ point.
The performance target is set in relation to cash with a time horizon expectation for achieving this desired return level (e.g. a rolling three-year period).
Key to this approach is setting a volatility risk budget that ensures a wide diversification of investment risks essential to delivering an ‘all weather’ performance profile.
With a cash benchmark, the manager is not restricted to a single investment strategy and can build a carefully selected portfolio of truly diversified investment strategies that encompass the whole fixed income spectrum, including credit and government bonds, as well as interest rates, inflation, volatility and currencies.
While it is difficult to predict future return levels, it is easier to foresee fixed income markets continuing to grow and develop, providing opportunities for active managers to add value.
For investors willing to take an absolute return approach, fixed income managers can look to maximise these opportunities through a diversified portfolio of investment strategies aimed at delivering positive investment returns for the requisite level of risk.
For information on our Absolute Return Global Bond Strategies Fund please visit our website: www.standardlifeinvestments.com