But, perhaps more worrying, given the recent gyrations in bond markets in recent weeks, of those allocations, was that the holdings tended to be highly correlated to each other.
According to the Natixis Portfolio Research & Consulting Group’s Portfolio Barometer publication for the first quarter of 2015, conservative portfolios held a median of three different fund managers. And, it said: “The research found that many fixed income categories held by conservative portfolios are very highly correlated with one another, particularly those categories that are more widely held.”
By way of example, it said, based on average inter-fund correlations over the three years to end March 2015, “‘Government’ fixed income funds have on average a 0.90 correlation to each other, a 0.69 correlation to “Corporate” fixed income funds and a negative -0.11 correlation to UK equities.”
The group also found that the frequently expressed fears about duration risk and the likelihood of a rise in yields in the future had filtered through to portfolios, with only one in five advisers on average holding pure government bond funds. And, among those holdings, Natixis said, while there was a growing allocation to short-dated funds, primary holdings remained in diversified all-maturity gilt funds.
“In contrast, pure investment grade corporate bond funds appear in two thirds of Conservative portfolios,” the group said, “making up approximately one third of total fixed income allocations. “
Here too, Natixis said, the trend toward short-dated funds continues to grow.
Matthew Riley, head of research, at Natixis’ Portfolio Research and Consulting Group said the decision to focus on corporate, rather than government debt has, in part, been driven by continued demand on the part of investors for income.
This decision, he said, has, so far, been proven right as corporate bond funds have outperformed government bond funds in terms of both risk and return.
But, he cautioned: “Advisers should be cautious, however, as the high correlations within these mainstream sectors make it difficult to achieve meaningful diversification.”
Another point of caution raised by the group is that the growing use of flexible fixed income funds, may not bring as much diversification as adviser may think.
“These funds serve either to complement other fixed income allocations, or with the expectation that a dedicated manager can react and reallocate between fixed income sectors more quickly than an adviser can…Many advisers held three or more such funds to help spread the risk of a manager making the wrong call. Despite this, the Natixis analysis found flexible fixed income funds to be very highly correlated with one another. The average correlation between two flexible funds from the sample group was 0.84, with the minimum being 0.67.
It added: “Equally concerning from a diversification perspective, the research found high correlations between flexible funds and those in other sectors, particularly corporate and high yield bonds, making it difficult for investors to escape high correlations even across seemingly different fixed income categories.”
