Fixed Income  

New avenues for fixed income investors

This article is part of
Alternative Investments - September 2014

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.