Our approach is built around a core of defensive bond alternatives that offer the potential of attractive risk-adjusted returns versus the broader fixed income universe. These are investments with bond-like characteristics that tend to have a relatively short maturity profile and low sensitivity to broader market moves.
As an example, the fund invests in a portfolio of zero-dividend preference shares, which is an area where we continue to find what we perceive to be better opportunities than can be found in the bond market.
ZDPs are debt instruments issued by companies, often investment companies, which do not pay a coupon but, at maturity, return the initial capital plus total accrued interest.
Our analysis has led us to believe that their credit quality is high. Despite this, the ZDP portfolio is offering gross redemption yields similar to that of high-yield bonds with similar maturities and significantly more than the return that UK gilts or AAA-rated UK corporate bonds would provide.
The specialist nature of the sector, the low maturity profile and the return premium relative to other sectors of the fixed income universe, have insulated the fund’s ZDP portfolio to the volatility experienced in the bond market so far this year.
We also have an allocation to alternative investments, which we think of as investments outside of the more conventional asset classes of equities and bonds.
Traditionally, the largest alternative asset classes have been hedge funds, real estate, infrastructure and private equity, but in recent years the range of opportunities, and how you can access those, has widened significantly. Examples of new asset classes we have recently gained exposure to include music royalties, energy efficiency projects and digital infrastructure.
The performance of alternative investments tends to be less sensitive to broader economic and financial market conditions and therefore can be a useful diversifier for portfolios.
In fact some positions, through, the use of derivatives may benefit from market volatility and therefore perform strongly while conventional asset classes are under stress. This has the effect of dampening overall portfolio volatility resulting in a smoother return profile for investors.
Although the objective of the alternative asset positions is to increase diversification and therefore reduce volatility, this is not to say the individual positions themselves are low risk. The difference is that the risk is more idiosyncratic than that of equity and bond positions, which tend to be more sensitive, especially in the short term, to market movements.
Often, alternative investments can be more complex than traditional assets, and a large amount of time is spent gaining a thorough understanding of the underlying investments, establishing the risks and opportunities and ultimately how they will affect the performance of the investments.