Almost six months ago, in January, the ‘tapering’ of the US’s unprecedented asset-buying policy, known as quantitative easing (QE), finally began. This triggered the beginning of the end of the ultra-loose monetary environment we have seen in the US in the past few years.
It is widely anticipated QE will be completely wound-up in September or October; whether interest rate rises will follow soon after is an important question for fixed income investors.
Consensus forecasts are for US rates to rise in the second half of next year but, just as the Bank of England governor Mark Carney has implied in the UK, it is possible a rise could come sooner, as the economy improves and a desire to return to more normal monetary conditions strengthens.
Such uncertainties are prompting investors to consider new approaches to complement traditional long-only fixed income strategies, as indicated by the high levels of retail inflows into the IMA’s Strategic Bond sector, while flows into other fixed income sectors have been slowing to almost nothing.
So what are investors looking for? They want solutions that are designed to be flexible and perform during different market conditions. Most pertinently, these strategies should have the ability to deliver meaningful returns over and above risk-free levels, as we go through a period of rising interest rates.
The hedge fund world has long been home to flexible, absolute return approaches to credit investing – free from benchmark constraints and able to invest across global corporate bond markets. Such strategies are becoming more common outside of hedge funds, although there are some notable differences in these newer breed strategies – the absence of performance fees and leverage are important ones, as well as the likelihood of tighter risk controls and more robust regulatory frameworks.
A good multi-asset credit portfolio should be able to generate returns from a wider number of sources than a traditional portfolio. Its manager will be able to use a range of techniques to capture highly attractive risk-adjusted returns, avoid out-of-favour sectors and – importantly – dampen volatility and hedge risk.
One of the distinctive features of multi-asset credit strategies that may help do this is the absence of standard benchmarks. Benchmarks are an integral part of fixed income investing, particularly when it comes to single sector/asset class portfolios. But traditional benchmarks carry interest-rate sensitivity by being tied to duration parameters. By removing the benchmark and link to duration, managers have far greater flexibility to control interest-rate risk and potentially enhance returns by allocating to assets with less sensitivity to duration as market conditions dictate.
The absence of a benchmark also means an investment manager can freely allocate between credit sectors. The dispersion of returns from major fixed income indices globally tells you that being tied to one or two markets may hamper return potential. For example, in 2013 and 2012 European high yield was the best performing fixed income asset class, but in 2011 it was the worst – while lower risk fixed income assets outperformed that year.