Julius Baer: Absolute return investing makes a comeback

This offers an excellent backdrop for relative value driven investment strategies as demonstrated over recent months by a number of established players in this space. We are convinced that absolute return bond funds – subject to proven management and a tested product design – should continue to deliver compelling returns at moderate risk.

The recent comeback for many risk assets from truly beaten-down levels has certainly helped to establish a growing sense of normalisation among investors. But let’s not be fooled. We are still operating in markets with little visibility both at the macro and micro level.

For as long as no broader consensus on the future path of the world economy and financial system is emerging, pricing action remains largely a function of swings in investor sentiment. The current buying frenzy in investment grade corporate bonds may serve as a case in point. Actively timing such markets in size while credit and event risks also run at very elevated levels bears plenty of risk.

From a bottom-up angle, one also must consider that after the largely indiscriminate sell-off triggered by the collapse of Lehman many single bond prices are still dramatically decoupled from underlyings. Once fundamentals come back into play we may well see bonds currently trading at 60 per cent re-pricing to 90 per cent but also vice versa. This will happen ultimately but not instantly as those market players traditionally capitalising on arbitrage situations – namely hedge funds or proprietary desks – today operate on much reduced fire power.

Why does all of this provide a compelling case for absolute return investing? Firstly, relative value focused strategies allow investors to bypass much of the directional market risk, thereby moderating timing issues while providing for much reduced volatility. Secondly, the sheer magnitude of pricing dislocations should allow not only the delivery of very competitive absolute returns but also a hard-to-beat risk/return and correlation profile.

As demonstrated time and again, smartly managed absolute return bond funds not only tend to offer attractive returns at moderate risk but also a very effective risk diversification within a portfolio context.

We are convinced that absolute return bond funds – subject to proven management capabilities and a tested product design – should continue to strongly outperform short-term investments like cash deposits and money market instruments as well as government and highly-rated corporate bonds.

Ralph Gasser is Product Specialist Fixed Income at Julius Baer. The views expressed here are his own.