New avenues for fixed income investors

The universe has broadened considerably in recent decades to include things such as high yield bonds, recently de rigueur but often derided as ‘junk bonds’ in the past. Now there are even more alternative fixed income options available to retail investors.

A lot of the new products have been inspired by the insistent search for yield that has occupied investors ever since interest rates hit record lows and investors realised they could not get much from a simple bank account, or even a simple government bond.

Increased interest

Investors have therefore been treated to new kinds of products, investing in areas such as asset-backed securities and loans.

Within the open-ended fund space these ‘niche’ instruments have largely remained the preserve of strategic bond managers, who have the flexibility to invest across the universe of fixed income markets.

But in the closed-ended investment trust arena there have been many more specific niche investment trusts being launched. Certain senior secured loans cannot be bought within a retail open-ended fund due to regulatory concerns about liquidity and risk within the market, so that gives the investment trust space an advantage.

Assets such as ABS are freely available to both fund structures, and TwentyFour Asset Management has developed a reputation in the past five years of providing solid access to the asset class, through its Monument Bond fund and its strategic bond fund, the Dynamic Bond fund.

Andrew Alexander, head of investments and product strategy at Three Counties, invests in the Monument Bond fund for his clients and says it should be “serious consideration due to the floating rate element to it”.

In the AIC Debt sector there have been six new trusts launched within the past 12 months and a total of 12 within the past three years, as fund groups and managers have realised the desire for such products.

The Neuberger Berman Global Floating Rate Income fund has already raised more than £1.2bn from investors through investing in senior secured corporate loans, which is one of those areas not accessible through retail open-ended rivals.

M&G recently tried to get around this by launching a Global Floating Rate High Yield fund for James Tomlins. The fund is the first of its kind in the open-ended space and has already attracted the interest of managers such as Simon Callow at Seneca Investment Managers.

Why invest

Mr Alexander says that more and more investors are now looking at these types of products because they “are possibly realising the risks associated with fixed income”.

He says that for a long time investors did not really appreciate the risks from fixed income but that now it is “no longer viewed as a risk-free asset with yields at historic prices determined by super loose monetary policy”.

Paul Surguy, head of managed funds at Sanlam Private Investments, agrees that the super loose monetary policy employed by developed world governments in recent years has sparked a move to alternative assets.

But he points to the unwinding of those policies as the catalyst for the acceleration of that interest in the past year or so.

Mr Surguy says: “I think the reasons many investors are looking at newer fixed income themes are due to the clear signal that rates will rise, and the ever present search for yield.”

The two issues are separate but both linked by the same cause: low interest rates and quantitative easing.

With interest rates set to rise, Mr Surguy explains that “many investors will want to minimise their interest rate exposure, which some of these different types of fixed income can do”.

Dealing with duration

The draw of loans and ABS both come down to this fear of rising interest rates.

Conventional bonds all have an exposure to interest rates, called ‘duration’. The higher the duration on the bond, the more exposure the investor has to movements in interest rates. This can be a good thing for returns when rates are going down, but investors are widely expected to lose money in conventional bonds if and when interest rates rise.

Mr Alexander says he uses ABS for rising interest rates, because the asset class is contains no duration so it should not be affected by rising rates.

Loans provide a further advantage in that they are typically ‘floating-rate’, so the yield they pay out rises in conjunction with rates and they can actually go up in value when interest rates rise.

But the area is still very niche, and vehicles outside plain ABS and loans are beginning to gain interest.

Risks

The FCA recently put a ban on marketing contingent convertible (CoCo) bonds to retail investors due to the risks associated with them.

The problem, as Mr Surguy puts it, is that “the risks are not fully understood”. Many for these assets are, if not new in overall terms, at least new to the retail space, and it is difficult to establish a long track record for such asset classes to find out what they do in various market environments.

Mr Alexander is more sanguine about the risks, and says that “they tend to be super low volatility so traditional downside is not the issue”.

Instead, he points to that low volatility and low risk as a potential concern in bullish markets. “I suppose it’s the possible lack of upside in a normal/rising market that would be a fundamental risk to client real returns,” he explains.

But he does think that such asset classes should be approached with extreme caution by direct investors, and even some professionals.

He says: “I would argue that it is not the investor’s place to fully understand the investment itself at an intrinsic ‘advice-giving’ level; what are they paying advice for?

“However, I would suggest that they may be too difficult for less educated and aware advisers to use. A simple solution is for the adviser to do sufficient due diligence before recommending.

He advocates that before buying into such funds, advisers must have an “awareness of the return anticipation and profile, an understanding of the asset class, an understanding of the manager process and ongoing knowledge of the manager’s current view and positioning versus the macro environment”.