Flexible fixed income funds have found favour in the past decade of low yields. Tanya Ashreena speaks to fund managers about active approaches by some of these funds to market volatility during the Covid pandemic.
In a market with low bond yields, investors have looked hard for ways to earn mid-to-high single-digit returns without the volatility they get from owning equities. This is where multi-asset bond funds have found a role in allocations.
Actively managed multi-asset bond funds have been sold to investors for their ability to deliver investors with strong and sometimes equity-like returns, but when compared with equities, they have offered more protection from capital losses.
Toby Nangle, who is global head of asset allocation and Emea head of multi-asset at Columbia Threadneedle Investments, says that during market volatility throughout the Covid-19 pandemic, funds with a multi-bond capability showed a unique capacity to find cheap credit securities following the March 2020 crash, but where risk profiles strengthened as prices recovered.
“Moreover, they have been able to change allocations across regions, currencies and asset classes through the worst quarter for global bond markets for more than 25 years that occurred at the start of 2021.”
More active and more flexible
Nick Samouilhan, a multi-asset strategist and portfolio manager at Wellington Management, says that when bond yields are low, the ability to protect against portfolio losses using their duration – a bond’s sensitivity to changes in interest rates – remains strong. This is one of the core roles fixed income plays in a portfolio.
However, he adds that the outlook for yields or duration is difficult to gather in the current context. This is because Covid-19 and its variants continue to affect markets, along with uncertainty around inflation rates and tapering – the gradual reduction of asset purchases by central banks.
In such a market, he says multi-asset credit funds are still attractive because they allow investors to be more active and flexible, and more subtle in duration.
Ariel Bezalel, head of strategy, fixed income at Jupiter Asset Management, says price volatility affects sentiment, another factor that makes multi-asset bond portfolios important.
“Volatility in prices and differences of opinions and analysis across the range of potential investments for a flexible fixed income fund remain,” he says. “And therein lies the opportunity to deliver alpha for clients with prices constantly readjusting to the ever-evolving macroeconomic and business landscape.”
Moreover, the pandemic has disadvantaged funds that are constrained by duration, credit rating or geographical mandate in this environment, as their alpha opportunities are equally constrained. “In this market, buy-and-hold won’t deliver the strong risk-adjusted returns investors need. A flexible fixed income fund is the product for a new low-yield world,” Bezalel says.
Fraser Lundie, head of credit at the international business of Federated Hermes, says that by combining unconstrained, high-conviction credit selection with a hedge against adverse market conditions, the firm’s multi-asset credit products can expect to maximise long-term total returns.
“Our approach provides a solution for investors seeking to outsource their full credit exposure, or enhance their traditional fixed income allocations,” he says. “In that sense, now is as good a time as any before in which to allocate.”
Lundie believes that multi-asset credit vehicles should generate capital growth and a high level of income over time if they can adopt an unconstrained, high-conviction approach to investing across the global liquid credit spectrum. The trick is capture superior relative value as investment conditions change, through instruments such as developed and emerging market investment grade and high yield corporate bonds. But loans, government securities, asset-backed securities and convertible bonds are in play, too, as are preferred stocks, credit default swaps, credit index options, interest rate instruments and other credit derivatives, Lundie says.
“Overall, we continue to see plenty of opportunities for alpha within credit markets and have options in place to provide a level of protection should the unexpected occur,” he says. “Because of this, we remain confident in our ability to deliver on our objective going forward, despite low market yields.”
Markets are fickle and turn their heads at news quickly, says David Newman, head of global high yield at Allianz Global Investors.
“We’re in a market where none of this has been seen before and we’re living day to day on the data. However, it’s not economic data at the moment; it’s medical data. So, flexibility is important and I think the multi-asset credit approach is better than the benchmark approach to give you that flexibility to react to the news flow.”
Watching the Fed
The outlook for most asset classes over the next few months, especially bonds, is dependent on the Federal Reserve tapering programme and any further reopening or lockdowns.
“While still very uncertain, the Fed will try and undertake a tapering process that will not result in significant increases in yields, while the hope is that the Delta wave will recede in the face of the vaccines and the global economy will reopen,” says Samouilhan at Wellington Management. “If that is the case, we are likely to see moderate pressure on yields and perhaps further credit spread tightening – which would be good for multi-asset credit funds.”
Fund managers, of course, have also been watching interest rates.
“Wages have gone up because of government support schemes, for example,” says Richard Batty, multi-asset fund manager at Invesco. He says it looks like inflation is moving some economies above target, but his belief is that eventually this will turn down – certainly by next year.
“The reason for raising rates prematurely is to counter that higher inflation that we think is misplaced, because inflation will eventually fall as economies settle down.”
Credit is a broad universe, so there are some areas and regions that look more attractive. A survey by Camradata of 891 investors in Europe revealed that 587 investors (66%) preferred broad bond strategies. These were followed by significantly fewer favouring corporates, duration, loans and asset-backed or mortgage-backed securities (see box).
“We continue to run a flexible ‘barbell’ strategy that holds carefully selected corporate bonds alongside medium and long-dated US and Australian government bonds, which aim to defend the portfolio against any adverse events that may occur in the coming months,” says Jupiter’s Bezalel.
Allianz’s Newman agrees. “The US has been coping better and if you look at the recent data, you’ll see a downtick in the Delta variant,” he says. “The UK is not doing badly and Europe is a little more mixed, while China’s system is dependent on the central bank’s policies on credit.”
Newman currently likes short-dated asset-backed securitisations, which give “a fairly decent pick-up versus short-dated credit”, and Asian property bonds. “There are some businesses in Indonesia, such as retail malls, where you get 5-6% yield and you are not seeing the ‘Amazonification’, which we see in the US.”
Some fund managers are sceptical about emerging markets. “We remain cautious around emerging market debt, given the uncertainties around the vaccine rollout and therefore the economic recovery in these regions,” Bezalel says.
On the other hand, he is bullish on developed markets: “Some developed market government bonds look attractive to us, given that a lot of the themes around demographics, excessive government and corporate debt, and the disruptive effect of new technology have not gone away and will in our view continue to exert downward pressure on bond yields.”
Against this backdrop, Bezalel continues to prefer sectors where businesses can still generate revenue despite the changing economic landscape. These are telecommunications, consumer staples and healthcare, he says. More selectivity is needed when choosing sectors where reopenings are causing revenues to rebound, he adds, citing airports as a prime example.
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