Fixed Income June 2017  

How to construct a portfolio for yield

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How to build a robust yield into a portfolio

However, he adds: “It is important to diversify into areas such as contingent convertibles (CoCos), which offer yield in excess of 5 per cent.

“These can help balance lower-yielding asset classes, which investors might still want to hold for their defensive properties (such as US treasuries). 

“This is one example of the barbell strategy we have been adopting this year, balancing defensive but lower-yielding markets with higher yielding opportunities, where our research is supportive for this outlook.”

Advisers considering this strategy however might want to outsource to a multi-asset or fixed income fund that invests cautiously and with proper research in CoCos, as the FCA has not really softened its stance on the retail market’s access to such investments.

In 2014, the City watchdog issued a note that it had restricted the distribution of CoCos to retail investors for a year, as these hybrid structures were considered to be too complicated for the average retail investor.

Indeed, in June this year, there was a complete writedown of such bonds at Spanish lender Banco Popular, when €1.25bn of its Additional Tier 1 bonds fell drastically, ending up trading at about half of face value.

This was, according to sister title the Financial Times, before the bank’s resolution and takeover by rival Santander was announced on the morning of 7 June. 

Hedging

Currency risk – as seen with the severe depreciation of sterling against the euro and the US dollar after the UK’s vote to leave the European Union last June – can cause problems for UK investors. 

It can certainly pose problems for bond holders and for those portions of a clients’ portfolio where investors hold either a foreign currency bond issued by an overseas entity, or by holding a bond denominated in a currency other than the domestic currency.

By using a currency hedge within a portfolio, an investor can not only be protected from huge swings in currency valuations, but also the hedge itself could provide a return.

According to Mr Leyland: “With our blessing, one of our investment partners started hedging out currency risk across our monthly income global income fund, which is a significant holding in our income models.”

Although the effect of Brexit talk, economic and political shocks at home and abroad have sent currency markets into little frenzies over the past 12 months, the idea of using currency risk hedging in bond portfolios is not new.

In fact, in a 2014 research note from the US arm of fund manager Vanguard, The buck stops here: Understanding the ‘hedge return’: The impact of currency hedging in foreign bonds, writers Charles Thomas, CFA and Paul M. Bosse summarised this as a means of risk management and providing an alternative income stream.