Remember the great rotation? Bond yields at historic lows and an improving growth environment were expected to drive investors out of fixed income and into equities at the start of 2013, but the prediction never came to pass.
In part, this was due to the realisation that growth wasn’t all it was cracked up to be. It was also because, for investors, it was never as simple as a straight swap between equities and fixed income.
But two years later, concerns over bonds remain – not least because they have continued to post stellar returns in the interim. The question now for asset allocators is exactly how they will replace this exposure, and the answer is both nuanced and uncertain.
Risk budgets mean bonds will never fall fully out of fashion, even at a time when concerns over valuations, liquidity, and duration are painting a pretty dismal picture for the asset class. The other difficulty is a lack of many viable alternatives.
As Ingenious Asset Management chief investment officer Guy Bowles explained: “The fascinating thing is […] where do we put fixed income money. There is no right or wrong answer”.
In any case, the gradual move out of fixed income remains just that: gradual. Investec Wealth & Investment, for example, attracted headlines earlier this year when it announced it was shifting part of its fixed income allocation into alternatives.
“The switch was driven by the belief that these alternative investments can be sensible options for reducing portfolio volatility when the more conventional options (in fixed income) become excessively expensive,” the company said.
Nonetheless, the wealth manager decreased its exposure to index-linked gilts and cash by just 1 per cent each, using this money to up its allocation to alternative investments such as hedge funds, absolute return funds and defensive structured products.
Ingenious’s Bowles, meanwhile, values qualities such as liquidity, transparency and low volatility, which lead him to higher cash weightings but also absolute return funds.
“[Replacing fixed income allocations] involves a compromise. Some firms decide not to compromise on anything and hold cash. Some compromise on liquidity and hold infrastructure. We didn’t feel happy about that. If a client phones on Monday, I want to be able to give them [their cash] on Friday.”
Meena Lakshmanan, head of investment solutions at Vestra Wealth, notes of the current conundrum: “It is not enough to just say, ‘I’m going to be low duration.’ You also need to be careful about how you are positioned within the curve.”
As equity markets wobble again this summer, it is worth pointing out that as of September 22, the £ High Yield, £ Strategic Bond and UK Gilts sectors had all eked out positive returns for the year – albeit perhaps not of the magnitude expected given stocks’ falls. All three have posted average returns of just under 1 per cent.
Ironically, it is this kind of return which has so attracted investors to low-risk absolute return bond portfolios in recent months: not so much slow and steady as deathly dull.