Whether or not you subscribe to Bill Gross’ assertion that the 30-year bond bull market is now over, there’s no doubt that wealth managers are finding it harder to replicate the growth and yield returns of yesteryear.
With such a murky macro picture, uncertainly about the impact of QE tapering and interest rate rises, surely it makes sense to leave the ‘micro’ asset allocation between the different fixed income classes to the self-proclaimed experts.
Tricky levers
With a variety of tricky levers to pull in terms of duration and yield management, and with a several different asset classes to choose from – gilts, Treasuries, emerging market debt, investment grade, high yield etc – a good strategic bond manager really does earn his/her stripes.
Created in 2008, the IMA’s Strategic Bond has proven something of a hit with investors. Still, allocation with one of these managers offers no guarantee of added alpha or outperformance versus traditional bond vehicles.
So how do you know you are with the right manager? For Dan Kemp of Albermarle Street Partners, the prevalence of credit specialists remains a challenge in the sector, tough this problem is being somewhat diluted by newer fund launches that are managed by macro-orientated investors who seek to add value primarily through genuine asset allocation.
“As a result of its long period of evolution, the sector is very diverse in its exposure profile,” he says.
“This can be illustrated by the cross correlation of funds within the sector. Over the past 36 months the average correlation between funds has been 0.7%. Crudely, this means that on average, only half of the performance of a fund can be explained by the behaviour of the other funds in the sector. The other half of returns can be attributed to the idiosyncratic risk accepted by the manager. Performance comparisons with the sector average are therefore virtually meaningless, yet they remain the most prevalent performance measurement used by constituents."
Liquidity issues
Picking a fund by peer group performance is not recommended then, though going forward issues of liquidity and concentration are likely to come more into play.
“Although the impact of concentration risk and its knock-on effect on capacity is being felt across the fund buying industry, it is at its most extreme in the strategic bond sector,” warns Kemp.
“Data from FE shows that only 10 out of 73 funds have attracted new capital of more than £50m over the over the past 12 months. Of this, 67% of new capital was directed to the M&G Optimal Income fund. Jupiter, L&G, AXA and Artemis were the other were the other main beneficiaries but each lagged M&G by a factor of 20.”
As a result, he points out that the M&G fund is more than five times larger than its nearest onshore rival: “While this concentration is an understandable reflection the outstanding track record, talent and resources of the M&G bond team, it nevertheless creates a systemic weakness in the strategic bond sector that has become over-reliant on a single fund.”
Of course, no sector is defined by one fund alone, and the flip side of this coin is that there are a number of less well-known ‘hidden gems’ that remain nimble, ideal choices for fund pickers looking to diversify from the usual suspects.
What bond?
“Now, the practical question you have to ask as a bond investor is perhaps the most important: what type of bond?” offers Nick Gartside, international chief investment officer, fixed income, JP Morgan Asset Management.
“After all, the risks and opportunities in the spectrum vary widely. The reality is that bond markets have changed and with that, a paradigm shift among bond investors has gotten under way. The challenge to find attractive returns among the bond pitfalls of recent years has caused a sea change toward flexible ‘multi-sector’ approaches.”
That the industry has reacted to the challenges of a modern fixed income market is commendable, and there are plenty of top-quality managers to choose from. The challenge for the future, if Gross’ predictions do prove right, may well be convincing investors to allocate to bonds in the first place.
