Sion Cole, executive director at UBS Global Asset Management, discusses the spectrum of active fixed income strategies available.
In our article in the 20 October edition of Professional Pensions we considered active versus passive within fixed income investing.
In this article we explore the range of active fixed income strategies and why unconstrained core plus offers a better option for investors. The importance of global macro economic and geopolitical developments on fixed income returns has never been greater.
Rising economic uncertainty, increased government intervention, differing central bank policy responses and even competitive currency devaluation provide a complex backdrop for investors to digest.
The resulting market volatility can be uncomfortable for the buy and hold investor. However for the active investor more volatility can bring more opportunity.
Fixed income spectrum
Moving away from passive towards the middle of the spectrum we have the traditional core long-only managers. These offer single sector strategies with few tools to use when looking to add value.
Adjusting the overall average maturity of bonds (duration), reflecting a preference for either long dated or short dated (yield curve) and potentially making an allocation to overseas bonds currency hedged (country) may be the limit.
Justifying active fees means delivering outperformance, but relying on a small number of views means a concentration of risks and a reliance on getting a few things just right.
A better option for investors
In contrast, to the right of the spectrum the options open to the unconstrained core plus manager allow for a much wider universe of potential investments and the construction of a portfolio with a greater diversification of active views.
This enables less concentration of risk and in our view the opportunity to target a higher return per unit of risk. We see the diversification of return sources as critical when trying to generate consistent outperformance of your chosen benchmark.
An unconstrained manager can diversify active views across the full opportunity spectrum; duration, yield curve, country allocation, currency, credit beta, credit sector and choice of security.
An additional way to diversify can be across time horizon by incorporating views that are more tactical and thematic as well as more long-term strategic views.
So a good unconstrained manager should be spending time thinking about optimal portfolio construction and in particular on the correlation of views in the portfolio and especially downside risk management.
We believe that when fixed income is used to generate additional return, i.e. not used primarily for liability matching purposes, then active management makes sense.
Within the active arena we believe the far right of the spectrum offers a better option for investors.
Unconstrained core plus mandates give a manager more freedom and hence a greater chance of adding value for their clients. This can be achieved without increasing risk (relative to liabilities) by as much as you might expect.
At UBS Global Asset Management our clients trust us with £155bn in fixed income assets (as at 30 June 2011).
A key differentiator is that we place a greater emphasis than many on the importance of understanding the global economic and market backdrop. Having regional teams of investment professionals on the ground locally allows us to obtain greater granularity of the drivers of the global economy and markets.
When it comes to corporate bonds the risk of default demonstrates the need to exercise caution. We place conservative limits on active credit bets, employ a team of credit analysts to undertake independent research and make sure we diversify our portfolios.
We use a full range of instruments to reflect both positive and negative views. These instruments also enable us to react nimbly to new opportunities.
To find out how your scheme could benefit from our expertise in this area please contact Sion Cole on 020 7901 5619.