Amidst the last few months of pain in the bond markets, the £4.8bn Dimensional Global Short Dated Bond fund has shifted to the top of the IA Global Bond sector ahead of its peers. 
Rising expectations for inflation and a stronger post-pandemic economic recovery have been some of the reasons attributed to the collapse in prices for long-dated US Treasury bonds. This has pushed yields higher and sparked havoc across the bond and equity markets.
After two consecutive years of fourth-quartile performance in 2019 and 2020, Dimensional’s systematic strategy gone is in the top quartile of its sector so far in 2021. It is down 0.06 per cent versus an average fall of 3.17 per cent from the average IA Global Bonds fund.
Dimensional approaches bonds with the idea that prices reflect everything you need to know about a bond’s expected return. The firm then creates systematic strategies around this, without making predictions or forecasts about the market or future interest rates.
“It's not our job to try and explain what's happening,” said Kipp Cummins, a senior portfolio manager at Dimensional. “It is to take the information that we that we see in bond prices, and systematically design strategies that that are able to capture these premiums particularly when they're expected to be higher.
“And when those expected premiums are going to be lower, or are forecast to be lower, then you dial it back and you don't take as much risk in terms of buying lower rated corporate bonds, or adding duration to the portfolio when the expected premiums are lower.
“That's the big benefit of a systematic approach. We're not trying to time the direction of rates, and make any kind of forecasts, we can still outperform our benchmarks by pursuing these premiums in a systematic way.”
Over the last three years, Dimensional Global Short Dated Bond has mitigated the impact of most of the major swings in the bond market with a top quartile annualised volatility of 0.88 per cent.
Performance of fund vs sector over 3yrs
Source: FE Analytics
Leading up to the March 2020 pandemic sell-off, Cummins revealed that the systematic approach at Dimensional went underweight riskier assets not because it saw a crash coming, but purely because of tight credit spreads.
“We know that there's information in bond prices in credit spreads,” he explained. “When credit spreads - the yield differential between a government and a corporate bond - are tight, when that difference is really low, the expected premium - the benefit that you're expected to get for owning a corporate bond relative to a much less risky government bond - is expected to be lower.
“So during these environments, when credit spreads are really tight, we at Dimensional using a systematic approach will underweight these riskier assets such as triple B- or single A-rated bonds and instead favour high grade government bonds.”
Before the outset of the Covid pandemic in March of last year, credit spreads were relatively tight and Dimensional’s bond strategy went overweight high-quality bonds.
Cummins said: “As soon as credit spreads started to widen out, a lot of people were asking themselves ‘should I be owning corporate bonds when there's a lot more risk in the marketplace?’
“It's during this time period, when credit spreads widen out and the expected premium for owning corporate bonds is higher, that our systematic approach means exactly when other people might be abandoning, that's when we lean in and we start buying credit.
“This is because we know that there's information in these prices, the premiums, that tell us that there's a higher likelihood that you'll be rewarded for owning credit.”
When credit spreads began to narrow just as quickly as they started to widen out during the crisis, Dimensional’s systematic approach to harvesting premiums began to pay off, Cummins said.
“As we started buying corporate bonds and credit spreads started coming back in, we were really rewarded for doing that,” he explained.
“This systematic approach did exactly what it was designed to do. We were able to harvest these premiums during an otherwise difficult year for a lot of bond managers.”
Even though the absolute level of yields may seem low relative to inflation expectations, Cummins said it was important understand that it doesn’t necessarily mean fixed income investments can’t have positive returns.
“It's not just the yield that matters, it's also the shape of the yield curve that matters,” he said. “Low interest rates, there’s absolutely no way around it particularly on the front end of the yield curve, but it's the shape of the curve and what yields might look like in three years, five years and 20 years that is also important.”
When thinking about the expected return of a bond, he noted that there are two main components: the yield and the shape of the yield curve.
“If you have a steep yield curve, if it's upwardly sloped, and you buy it at a steeper portion of the curve, you hold it for a period of time and then you sell it at a future date. Then you can actually produce a positive return despite a low level of rates,” Cummins said.
“That's the other component of a bond return that is very important that I think a lot of people really miss. From our point of view, it is equally as important as the level of yields. Those positive returns come from the very shapes of yield curves, which are absolutely important.”
Performance of fund vs sector since launch
Source: FE Analytics
Since inception in 2004, the Dimensional Global Short Dated Bond fund has delivered a total return of 62.2 per cent versus 118.46 per cent from the average fund in the IA Global Bond sector. It has an ongoing charges figure of 0.28 per cent, and currently yields 1.2 per cent.