Lessons learned in the last decade: returns can only come if we accept risk
For these two reasons, absolute return bond funds have struggled to match the expectations of their investors over the past decade. Most have repeatedly failed to protect them in down markets. And where funds have protected their investors from drawdowns, it has generally come at the expense of generating long-term returns.
In the absence of a crystal ball, the only way to suppress market volatility is to run a lot of short positions to cancel out market movements. But as we have seen, running short positions in the bond market over the long term simply means repeatedly paying out lots of money…
My co-manager, Juan, and I have 20 years’ combined experience in managing absolute return bond funds – including a decade spent running a large absolute return fund together. We learned a lot of valuable lessons in that time. The most important one is this: attempting to deliver positive returns in all market conditions is a noble quest – but it is doomed to fail. It is an unbreakable law that returns can only come if we accept risk.
From ‘absolute return’ to ‘target return’…
Many of the concepts and techniques used by managers of absolute return bond funds remain perfectly valid and fit for purpose. But we accept the limitations of the asset class. Fund managers should be straight with investors as to what can be achieved within the fixed income market – and what can’t.
This is why our new Artemis Target Return Bond Fund is explicitly a ‘target return’ fund, which aims to deliver 2.5% per annum above the Bank of England’s base rate, rather than an ‘absolute return’ fund. We wouldn’t be able to meet that target if the income that is naturally generated by owning bonds goes immediately back out the door through persistent hedging.
We therefore take measured risks across three distinct modules:
- A carry module: the most defensive part of the fund, holding short-dated investment-grade bonds
- A credit module: absolute and relative positions in the investment-grade, high-yield and emerging bond markets
- A rates module: looking for opportunities – whether through curve trades, cross-market trades or inflation positions – in government bond markets
Performance attribution by module
Source: Artemis. As at 31 August 2021
We limit the proportion of the fund that can be invested in any one of these modules, and so limit the fund’s exposure to particular forms of risk (such as interest-rate risk or credit risk).
Yet we accept there will be some modest degree of volatility in the short term. Our experience over the past decade has shown that the short-term bumps will be naturally smoothed out in time.
As the fund’s returns since launch suggest, we think that is a trade-off well worth making – and that the move from ‘absolute return’ to ‘target return’ is one worth taking.
Author Stephen Snowden
Stephen Snowden co-manages the Artemis Target Return Bond Fund alongside Juan Valenzuela.
1. Data as at 6 October 2021.
FOR PROFESSIONAL AND/OR QUALIFIED INVESTORS ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. CAPITAL AT RISK. All financial investments involve taking risk which means investors may not get back the amount initially invested.