As a result, investors are having to consider alternatives to long-only funds in the search for positive returns.Russ Oxley (pictured), head of rates at Ignis and manager of the leading Ignis Absolute Return Government Bond fund, has long been anticipating this turn in the investment cycle, saying: "Investors need to adjust to a period of increased volatility, characterised by rising real yields on a global basis and, therefore, should consider absolute return strategies for their fixed income allocation, which are able to deliver alpha rather than rely on beta-driven gains."
The Ignis Absolute Return Government Bond fund has been designed for the purpose of delivering positive performance in all market conditions and the fund has managed to not only outperform over the summer months, but has continued to deliver steady, cash-topping returns over the medium-term.
The £1.5bn fund has made 5.19 per cent over the last 12 months, but its strongest returns came over the last six months, when it delivered top-quartile returns of 3.24 per cent.
The IMA Targeted Absolute Return sector made just 1.11 per cent over this period.
Performance of fund vs sector over 6 months
Source: FE Analytics
Like many absolute return funds, the Ignis Absolute Return Government Bond fund’s objective is to deliver positive total returns that are independent of market conditions. However, Oxley says the team takes a different approach to managing fixed income than many of its peers.
"The traditional process focuses on duration – the measure of how much the price of a bond will change for a given change in its interest rate," he said.
"Duration implicitly assumes that the discount yield curve can only move in parallel, but this conceals a huge amount of information."
"The rates team adopts a different approach, instead looking at forward rates – the interest rates for specific periods in the future. By looking at government bonds of different maturities, it is possible to work out the expected rate for one year in, say, three or five years’ time."
"This process gives Ignis two main advantages over an approach based on duration. First it allows the rates team to form a fundamental view based on more and better information. Secondly it allows the portfolio manager to implement those fundamental views by trading a higher number of less correlated positions."
"Essentially, forward rates provide a means of systemising a complex world," he added.
Oxley says the team uses a five-step process to select fund positions.
- Identify key macroeconomic themes and trends through fundamental research and in-depth intellectual debate. All the usual inputs are used in the process – research, economic release and central bank reports.
- The second stage is to analyse forward rate curves to find the optimal expression of the view. The team’s proprietary software system, ClearCurve, is used at this point to analyse the opportunities available to best reflect the team’s macro views.
- The team then expresses these views through multiple positions to increase diversification and reduce idiosyncratic risk. The process is constructed based on the premise that implementing macro views through as wide a range of uncorrelated positions as possible improves the risk/return profile of the portfolio.
- The fourth step is to allocate risk to trades depending on risk characteristics. This step seeks to review each new trade in the context of the wider portfolio to ascertain the impact on the risk and return characteristics of the fund.
The portfolio tends to reflect around five macro views at any one time, however Oxley states that the team invests pragmatically and will tactically trade around these positions to reduce exposure to short-term market moves.
The fund sticks to holdings from individual countries, or sovereigns, and mixes these holdings with cash and cash-related assets.
It concentrates mainly on investment in bonds issued by the G10 group of nations, with a particular preference for US Treasuries, UK gilts and German Bunds, which are the most liquid markets.
The strategy also invests in bonds issued by the governments of Japan, Canada and Australia, as well as other highly rated eurozone governments.
Since the fund is taking a different view than most fixed income portfolios, Oxley says the Ignis Absolute Return Government Bond fund can have a diversifying effect on an investment portfolio as it has an extremely low correlation with other assets.
"A well-diversified portfolio should be able to withstand the stresses of a challenging economic climate, because different pools of assets will perform differently according to the environment," he said.
Click here to learn more about absolute return investment strategies, with the FE Trustnet guide to absolute return.
This article was written in collaboration with and is sponsored by Ignis Asset Management.
