Is there any point in holding fixed income funds any more?
Bernard Aybran, Invesco
Most investors need income, which is why bonds still have an important role to play in portfolios despite low interest rates. But fund selectors must pay attention to liquidity
Records are meant to be broken. And indeed they are, at least in bond markets. Whether you look at size or yield, many areas of the wider fixed income universe are standing at record levels: very often record lows for the latter and record highs for the former.
While this combination sounds somewhat puzzling, or even toxic, investors in funds have to cope with it. The good news is the asset management industry offers a vast range of solutions, depending on investors’ need.
It is more about history than fund management, really. But still, it tells a lot: for example, data available on Dutch government bonds since 1517 shows that over the course of five centuries – where the country went through wars, epidemics, inflation and deflation – 10-year interest rates have never been this low. Outside of the eurozone, the situation is quite similar when you look at the Bank of England’s base rate over the past centuries.
More broadly, the very low level of interest rates in major Western economies triggered what is usually referred to as the hunt for yield: most investors worldwide, whether institutional or private, need some positive income. And in some cases, with sizeable assets under management, investors need to be invested in fixed income, because of specific regulation, or in order to make their assets and liabilities consistent with each other.
Investors looking for yield could be better off after the bout of volatility in the summer: major parts of the bond markets are yielding more today than they did a decade ago (when comparing yields on August 2015 with yields on August 2005). This is true for emerging corporate bonds or the debt issued by emerging governments in their own local currencies. Even the classic dollar emerging or high yield corporate bonds have, on average, a yield that is very close to their level 10 years ago.
For all these “traditional” higher yielding securities, there are funds managed by dedicated boutiques or wider groups. Which one makes more sense for the investor? It is usually accepted that in bond markets, the bigger the better, because of the size needed to access information in a market that is over-the-counter (OTC) by nature, and subject to major information asymmetries.
There is another major difference for fund selectors between today and a decade ago: many dedicated products have been launched and scarcity of supply is no longer an issue in most parts of the bond markets.
On the other side of the spectrum in the fixed income universe, a growing number of asset managers promote unconstrained bond funds. They usually claim they can seize opportunities wherever they are: corporate or sovereigns, emerging or developed, high yield or investment grade, including in many cases an FX overlay designed to magnify the overall risk return profile. Here, even more than in niche products, size matters. Having dedicated teams for each sub-asset class takes a vast pool of assets, most probably too large for boutiques.
But even by sticking with the major groups, some funds are more “unconstrained” than others and deviations from benchmarks can differ quite a lot depending on the firm and the team. In this case, even more than with usual, more focused funds, the ability for fund houses to show performance attributions is key for investors if they are to understand where the real value added comes from.
Whatever the type of fund an investor is looking at, there is a constant issue they should spend time on: the liquidity of the portfolio. While this topic used to be solely relevant for the more “niche” parts of the market, regulators now reckon it is a concern they have throughout the whole fixed income universe.
In the latest Report on trends, risks and vulnerabilities, the European Securities and Markets Authority (ESMA) assesses that the risk level is “very high”, which is the highest level in their ranking system. Fund houses tend to tackle this issue in very different ways: holding an increased amount of cash, increasing the number of holdings or increasing the number of traders. Fund selectors have to be on top of how their fund managers handle the liquidity issue.
While fixed income might sound boring to some, it is actually at the forefront of innovative techniques in capital markets and must be monitored carefully by fund selectors.
Bernard Aybran is CIO multi-management at Invesco
