Fixed income investors may have to increase their equity exposure if they want to deliver the kind of returns traditionally associated bonds, according to SYZ Asset Management’s Adrien Pichoud. 
Pichoud, manager of the £136.5m SYZ Oyster Absolute Return GBP fund, said that he has had to make changes to his portfolio to ensure that it is able to deliver the lower risk and steady performance that bond investors have come to expect.
“Our approach puts full emphasis on delivering the highest return and also managing the risk of the portfolio to make sure that volatility remains contained,” he explained.
Typically, the fund holds between 70 and 85 per cent of its assets in fixed income, with the equity allocation capped at 25 per cent. However, in the low-rate environment, the fixed income part of the portfolio has started to come under more pressure and asset allocation has become more important than ever.
“It is a challenge in the sense that it reduces the return that can be generated from the fixed income part, at least on a structural basis,” he said. “I also manage similar strategies in euro and Swiss francs, but it’s a little bit easier, at the moment, to manage a sterling-based portfolio because even short-dated bonds or treasuries or gilts – instruments like that – do provide quality returns.
“That being said, the returns of the yields generated here are not very high and our structural view is that the low-yield environment is going to remain for a while and therefore we have to adapt the way we manage.”
While equities would traditionally be used in the portfolio to provide some protection from interest rate risk, they are now being relied upon to provide income in the portfolio.
“In the past, you had equities that were here [in the portfolio] for price appreciation and fixed income that was here for income generation,” he explained. “Today, the fund has less [in fixed income] and the equity part has to also have some income generation in order to compensate for the lower income that is generated from the bond part.”
As such, the fund now has a higher allocation to high-dividend global stocks.
Another consequence of the low-rate environment is that fixed income funds now have a lower tolerance to drawdown from investors.
“When you have higher returns, then you can tolerate some level of drawdown because your recovery [period] is relatively short,” explained Pichoud. “But the lower the return, the magnitude of the acceptable drawdown also becomes lower and this is why the management of portfolio risk and volatility becomes even more important in this low-yield environment.
“The way we address this situation is to make sure we also get some income from the equity part. We also make sure that we have processes in place to more strictly control the overall risk and volatility in the portfolio to limit drawdowns and to generate performance with as low a volatility as possible. Even if it comes at the expense of market opportunities.”
He added: “We are not ready to take any risk to generate performance and we are very much thinking in terms of risk-adjusted expected returns. In a low-rate environment, any significant drawdown becomes more painful for our investors and for the strategy.”
Last year Oyster Absolute Return fell 4 per cent, however, Pichoud said that performance needs to be considered against the wider backdrop where all asset classes went down.
“Of course, we did our best to contain the drawdown and to some extent we managed that with asset allocation,” he explained. “But it was very difficult to completely offset the fact that all markets and all assets went down last year.”
Performance of fund YTD
Source: FE Analytics
In 2019, however, things have been different with the absolute return fund making a 6.84 per cent gain (to 4 December).
“This year, all assets have been going up, so putting in a positive performance is not, let's say, an achievement,” he said. “Where I think we delivered on our mandate is that we managed to participate in the positive performance on the fixed income side and the equity side.
“We managed to deploy our risk in the portfolio in a way that allowed us to participate and benefit from some trends.”
For instance, the fund’s increased emerging market debt allocation at the start of the year benefited from the Federal Reserve’s decision to reverse its tightening regime.
Another allocation decision that benefited the fund was its allocation to gold and precious metals at the end of 2018. Pichoud said this was due to its view on interest rates going lower, which supported gold prices. The allocation also helped lower the overall volatility of the portfolio, particularly given its lack of correlation to fixed income and equities.
Its equity positioning, which was more defensive for much of the year, outperformed more cyclical parts of the market. However, as the outlook has improved in recent months, the manager has taken action to neutralise the defensive part of the equity allocation and increase exposure to cyclical stocks where valuations look more attractive.
“Because of this large valuation gap, we felt that it was becoming dangerous from a risk management perspective to maintain such a strong bias towards defensives,” he said. “Not that we’re negative on that part of the market, but we felt the potential for outperformance had been reduced based on our valuation metrics.”
The SYZ manager added: “Our view of the world is that we remain relatively constructive on global growth. We don't think we are about to enter a global recession, we think that the support provided by central banks will keep economies going.
“There is a big downside risk on growth – a tail risk that does exist – that is not our central scenario. But we acknowledge that in any case, it implies that central banks will remain very accommodative and rates are unlikely to rise much.”
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since launch, SYZ Oyster Absolute Return has made 9.83 per cent against a return of 2.52 per cent from its LIBOR 1 Month GBP benchmark and a 7.22 per cent gain for its average IA Targeted Absolute Return peer (it should be noted that the sector is home to a range of strategies). The fund has a yield to maturity of 1.7 per cent and an ongoing charges figure (OCF) of 0.74 per cent.