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Does your portfolio need an absolute return bond fund?

27 May 2015

Many investors are worried about the future direction of the fixed income market, leading some experts to argue they should be looking at funds that aim to make a return no matter what headwinds emerge for bonds.

By Gary Jackson,

News Editor, FE Trustnet

Bonds have returned to the spotlight in recent weeks after a strong sell-off prompted losses for many investors in the asset class. Does this mean fixed-income funds with an absolute return mandate are the best option from here?

Since the start of April, the average fund in every bond sector apart from IA Sterling High Yield has posted losses after concern over extreme valuations, the timing of the Federal Reserve’s first rate hike and the prospect of better than expected growth in Europe damaged sentiment towards the asset class.

As the graph below shows, funds in the IA Global Bonds sector have been the worst hit with a 2.94 per cent average loss while the typical IA UK Gilts fund has dropped 2.93 per cent. The average high-yield fund, however, has made 0.90 per cent.

Performance of sectors since 1 Apr 2015

 

Source: FE Analytics

The scale of the bond sell-off – some parts of the market, such as German bunds were hit by their worse two-day losses since the depths of the eurozone debt crisis – has sparked debate on whether this is a temporary blip or the end of the three-decade bull run in the asset class.

Yesterday, City Financial head of multi-asset Mark Harris told FE Trustnet: “Is this a correction or a change in trend? That's the big question for everyone.” 

“We are still working it through but I suspect, at this stage, it is more of a correction than a complete trend change. However, we think it is extremely difficult to make money from bond markets at the moment but it is easy to lose money and lose it very quickly.”

With this in mind, some investors have been looking to absolute return bond funds as a way to eke out returns in the challenging market conditions.

The Investment Association universe has around 13 funds that specialise in investing this way, including Standard Life Investments Absolute Return Global Bond Strategies, BlackRock Absolute Return Bond and Schroder Absolute Return Bond.

Bill Eigen, chief investment officer for absolute return and opportunistic fixed income at JP Morgan Asset Management, runs the JPM Investments Income Opportunity fund, which has an absolute return mandate and prioritises capital preservation.

He believes the current bond market conditions, which has seen yields driven down to historic lows by six years of unprecedented monetary easing by the world’s central banks, is throwing up problems that many traditional bond funds are ill-equipped to tackle.


Performance of fund vs sector since launch

 

Source: FE Analytics

“In some respects, investors have always thought of fixed income as an ‘absolute return’ asset class. For decades they have relied on it to deliver capital preservation, income, and diversification from risk assets. A 30-year bond bull market fostered an environment where investors were lulled into complacency, used to outsized returns and low volatility,” he said.

“However, a major source of those stable returns have been duration or interest rate risk, which has been a powerful stabilising force in fixed income and the only real source of diversification versus riskier assets. Now with global yields at all-time lows, duration turns from a stabilising force for portfolios into a potential source of losses should rates normalise.”

Eigen (pictured) has been vocal in the past about the seemingly perilous condition of the fixed-income market, telling FE Trustnet in January that most conventional bond funds are guaranteed to lose money because the market has essentially been “broken” by central bank policy. 

“The fixed income landscape is changing and presenting investors with new risks and opportunities. Historically low income is forcing investors to reconsider their objectives, while high correlations across asset classes are creating obstacles around diversification,” he told us this week.

“Coupled with the prospect of higher rates, the need for diversification and steady returns has never been more important. Absolute return fixed income can deliver on this proposition, in today’s market and all markets.”

Bambos Hambi, head of fund of funds at Standard Life Investments, is a fan of absolute return bond funds. Avoiding gilts because of their expense and low yields relative to history, the manager prefers absolute return bond funds as a way to make money in downturns.

He recently sold the PIMCO GIS Unconstrained Bond fund following the departure of fixed income veteran Bill Gross. He replaced it in his MyFolio Multi-Manager Growth and Income ranges with the BNY Mellon Absolute Return Bond fund.

“This is run by the Insight team. Many years ago I worked with the majority of that team over at Rothschild Asset Management and they are highly rated. My team rate them very highly and this is a fund that just ekes out returns,” Hambi said.

“It’s not taking big bets, it just looks for cash plus 2 or 3 per cent. It has lots of different sources for adding value and interestingly over the last four weeks we’ve seen some bond funds fall up to 8 per cent but this is up 0.4 per cent. It’s doing exactly what we expect from it.”


The Ireland-domiciled BNY Mellon Absolute Return Bond fund was launched in November 2012 and since then has returned 4.15 per cent. Given its focus on bonds, this is a lower return that the typical absolute return fund but the BNY Mellon portfolio has been less volatile than its average peer.

Other highly rated absolute return bond portfolios include Stephen Snowden and Colin Finlayson’s Kames Absolute Return Bond fund, which holds five FE Crowns. Kames has stopped actively marketing the fund as it is approaching capacity.

Since launch it has returned 7.77 per cent, which as expected is below the average return in the sector but well above the 2.39 per cent rise in its benchmark of three-month sterling Libor.

Meanwhile, its annualised volatility since launch has been 0.62 per cent while its maximum drawdown has been just 0.13 per cent. This compares with volatility of 1.97 per cent from the average IA Targeted Absolute Return fund and a 1.64 per cent maximum drawdown.

Performance of fund vs sector and index since launch

 

Source: FE Analytics

However, not all convinced that investors need to allocate specifically to absolute return bond funds. David Coombs, head of multi-asset investments at Rathbones, no longer owns any of these funds and thinks better opportunities lie elsewhere.

“I have invested in them in the past and didn’t have a particularly great experience – I think it’s probably harder now than it was when I used to invest in them. I think they’re going to struggle to make decent returns given the low level of yields,” Coombs said.

“They have headwinds in the form of low real yields and higher fees and I just think they are going to struggle justify generating returns without taking higher levels of risk. I just think the odds are against you. I’m sure one or two will do really, really well but that’s a tough old strategy to run at the moment.”

“If you want to invest in absolute return funds, you’d be much better off in macro funds where you have specialists in that area that are looking to exploit volatility everywhere.”

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