Between an ageing population looking to preserve pension money and millennials dipping their toes into the investment pool for the first time, many see bonds as a natural first step in financial planning.
After all, fixed income funds have long been thought of as a safe bet, generating enough return to keep investors happy while also ensuring money doesn’t get lost in the twists and turns of a treacherous equity market.
But, as spreads widen, investors are beginning to look beyond traditional benchmark products. Suddenly, the risk-free returns expected of run-of-the-mill bond funds are starting to look a bit more like return-free risk investments.
This is setting the stage for bond portfolio managers to expand their horizons, looking to alternative strategies such as absolute return to generate returns.
According to Mark Dowding, head of investment grade bond funds at BlueBay Asset Management, demand for the firm’s Investment Grade Absolute Return Bond fund has grown over the past few years, and the product has become a priority for the company.
‘As investors came to realise that traditional fixed income doesn’t offer you much in terms of return, people were actually worried about losing money. What used to look like a safe asset all of a sudden didn’t look so safe,’ says Dowding, who also heads the BlueBay Global Sovereign Opportunities, Investment Grade Euro Aggregate Bond and Investment Grade European Government Bond funds.
For investment managers, delivering alpha to customers has become more difficult. This is why Dowding believes more investors are looking into atypical strategies.
‘I’ve spent 25 years in markets and have observed yields going ever lower. Inflation has come down and interest rates have come down. We’ve had this big bull market for fixed income, but now we’re all painfully aware that one of the things about benchmark fixed income is that you can’t cheat the max.
‘If you’ve got a benchmark delivering a yield of zero, it means that unless you go even lower, the return you’re going to get is nothing. Investors who are looking to maximise returns and own assets that they view as safe may move away from more traditional benchmark products in the direction of absolute return.’
Since its inception, BlueBay has been running absolute return money in hedge funds and Ucits alongside its more traditional strategies, which Dowding says has helped the firm catch flows going in that direction.
The standalone Investment Grade Absolute Return Bond fund was launched in 2013 with the objective of delivering cash returns plus 3%, which it has delivered with a volatility just over 2%.
Making a comeback
The fund now holds CHF 3.2 billion in assets, and has returned -0.66% in CHF terms over five years, compared with the sector average of -1.80%. In terms of returns over the past year, it has done better, with returns of 0.03% – comfortably ahead of the sector average of -2.23%.
Although the fund now has substantial assets under management, it hasn’t always been so popular with investors. In 2015 and 2016 the fund lost around CHF 2.8 billion over 12 months, dropping from its peak of CHF 6.4 billion.
According to Dowding, this was spurred by a series of bad investment calls that threatened performance and spooked investors.
‘It was a disappointing period particularly because we’d been long in credit exposure in 2015 and in the US energy sector we’d taken some loses and closed positions after the oil pipe spill. We rotated into the financial sector, where we saw losses again, so we booked losses on the corporate credit side,’ Dowding says.
In a bid to turn performance around, Dowding decided to reshuffle his team and take back the reins.
‘Obviously, I was very disappointed by that weak run of investment
performance. In this particular fund, I had taken very much a back seat, but from the end of Q1 2016 I took on day-to-day management of the fund.
‘This fund is one we’ve felt very passionately about. We’ve thought it’s
important to the future of BlueBay. When it wasn’t working, we didn’t want to rest on our laurels. We wanted to really focus on how to strengthen the performance proposition.’
Dowding notes that over the past 18 months, assets under management have begun to increase once again – a testament to both the fund’s improving performance and renewed investor interest in absolute return. Looking at the performance figures in detail, Dowding’s return has coincided with a strong run for the fund, which has returned 3.69% since April 2016 compared with the
sector average of -1.50%.
Bond flows and Bitcoin
Dowding says recent inflows to bonds may also be influenced by a slowing equity market. ‘I think from a retail perspective in Europe, maybe equities have been rather disappointing. Many investors have been somewhat disillusioned,’ he says. Furthermore, Dowding notes that geopolitical tension may be swaying investors into more defensive portfolios.
‘I think what you will observe is that there will be periods when fear
dominates greed, and other periods where greed dominates fear. It felt like towards the end of last year and coming into 2018, fear was starting to drop and greed was taking over. The clearest demonstration of that was the interest in Bitcoin and other coins being issued. There was this desire to get rich quick and it was all people were talking about for a time.
‘2018 has been interesting because the global economy is doing pretty well. But you’ve seen fears building around trade policy, fears in emerging markets, and it has felt like one after the other. There’s been political newsflow dominating, and maybe that’s pushed investors toward a more defensive position.’
Going for Greece
While investors may be worried about geopolitical instability around the world, Dowding has his sights set on Greece, expecting the fallen economy to make a comeback.
‘We’ve seen value in the European periphery. For example, we have liked Greece. It’s a market where we feel the economic turnaround is under way, and we expect their credit rating to rise having emerged from its programme more recently,’ he says.
‘We also think Greek government bonds look cheap compared with other countries who were in a similar situation, like Portugal. This would be another example of where we think there’s value to
be extracted in spreads on the long side.’
Dowding also believes European breakup fears are unlikely to be realised, and are driven in part by manager bias.
‘A lot of the money around the world tends to be run by Anglo-Saxons. By and large those coming from an Anglo-Saxon viewpoint tend to have this mindset where we look at a monetary union and say, “What on earth are all these countries, these different economies with their different languages, different cultures and different customs with this
history of fighting each other, doing together in this monetary union? Surely it’s destined to fall apart.” There’s this almost intrinsic bearish view on markets toward spreads in the periphery.’
While he’s positive on Greece, Dowding says he has a very negative assessment of the UK, believing the Brexit negotiation is ‘going to be
‘We think that through this period there’s a landscape for the pound to remain weak and for gilt yields to rise. We feel UK assets in general are thematically unattractive, so we would want to be positioned on the short side on both gilt and the pound,’ he says.
Dowding says bond yields across the board are unlikely to rise or fall much anytime soon, though he believes the end of 2018 may give way to an upward swing.
‘We are inclined to believe that as we move to the end of 2018, there’s a chance yields will start to rise again if the economic outlook going into 2019 remains strong. The US economy currently looks to be on a very solid path, and for the first time in 50 years we’re witnessing a big fiscal easing when the economy simply doesn’t need it. Here we see a big fiscal ease, on the back of the tax cuts being delivered, coming into an economy doing quite well.
‘This means we’re inclined to look for interest rates to continue to rise in the US in 2019, and we think there will be opportunities to take short positions in 2019.’
This article originally appeared in the October issue of Citywire Switzerland magazine.