This is beginning to happen, alongside a shortening of the product development cycle, which would make it easier to predict what will be popular at the point institutional investors allocate assets.
“We are sometimes happy to rate a product positively even it doesn’t have a five yeartrack record,” Miles says. “Products that have demonstrated good performance over several cycles are often closed or have very high fees. It is important to put less weight on track record and have the ability to assess a manager’s skill separately by looking in more granularity at how the strategy works, for example, looking at stock mistakes and talking them through with the manager.”
Shorter track record, greater risk?
One product designed to deal with the inevitable inflection point as yields normalise when quantitative easing begins to end, is absolute return fixed income (ARFI). A plethora of these funds have been launched in recent years by managers large and small and adopted by institutional investors.
According to Olivier Lebleu, head of non-US distribution for Old Mutual Asset Management International: “The cycle of adoption has become shorter as people have anticipated the need for absolute return fixed income, but those products have not been tested by sustained bear market conditions in fixed income markets.”
An all-weather bond strategy should be attractive to institutions given the likelihood of a market correction. The Fed may not have announced the taper formally yet, but the direction is set and Bank of England governor, Mark Carney, has signalled a strongerthan- expected recovery in the UK.
This coming period where yields increase and spreads widen will be an “acid test” for ARFI funds, as Andrew Dyson, head of global distribution for Affiliated Managers Group (AMG) describes it: “Many managers have not had to show any aptitude in running those products yet. If they are genuine absolute return products, they will prove very attractive as they fit the secular shift.”
Events in May proved the difficulties of making money in falling bond markets. Diversification alone won’t protect capital. During Q2 as yields rose sharply in response to ‘ taper talk’, the Citigroup World Government index fell 2.97%, the Merrill Lynch Corporate index fell 2.39%, the Barclays Global Aggregate fell 2.79%, the BofA Merrill Global High Yield index fell 1.48% while the JP Morgan Global EMBI (USD debt of EM) and GBI-EM (local currency debt, unhedged) indexes fell 5.64% and 7.34% respectively.
“You basically have to be short in a falling fixed income market,” OMAM’s Lebleu says. “There is nowhere to hide if you are long. There will be a very sharp correction in bond prices and only those in genuine absolute return products will be happy.”
In this regard, track record is crucial in showing a manager has the ability to implement short positions in fixed income, which is considerably trickier than for equity.
“As with equity hedge funds, you need evidence a manager knows how to short,” Lebleu emphasises. “Lots of managers can make the rationale for shorting fixed income sound good, but it is a different thing to be able to implement it. There aren’t many managers that have done so over several market cycles. The question of whether fixed income absolute return funds will turn out to be genuine is the top concern for investors at the moment in terms of products.”
Let someone else decide?
Sitting at the heart of ARFI’s proposition is their greater flexibility to use a wide range of instruments to reduce volatility and protect capital. This relies on the basic assumption managers are able to effectively implement those instruments in the portfolio, but also that they can identify the points at which each sub-segment of the asset class is going to be popular early enough to avoid missing the sweet spot.
This tactical asset allocation is prevalent across the multi-asset and diversified growth funds gaining popularity.
As Bluebay institutional portfolio manager, Blair Read says: “The ability to allocate between sectors of the fixed income market will be critical to success over the coming years as the unwinding of QE is likely to involve sporadic pockets of volatility which, via asset allocation, can potentially be avoided. Multi-asset credit also allows the investor to outsource the decision of which market to be in at various points of the cycle.”
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