Two fund managers have warned investors to prepare for a new landscape in fixed income investing as quantitative easing ends in the US.
Alliance Bernstein and Threadneedle Investments spoke in separate sessions at the Fiduciary Investors Symposium at Peppers Moonah Links, in the Mornington Peninsula, but both had similar warnings of a growth in volatility and the need for more active strategies in fixed income.
Alison Martier, senior portfolio manager and director—fixed income senior portfolio manager team at Alliance Bernstein, said the impact of quantitative easing had distorted the market and would eventually lead to greater volatility.
“As the Fed moves from QE and low illiquidity, so investors more than ever need to understand the role their fixed income plays in a portfolio,” she said. “Increasingly in the public markets investors needs to be thinking about the return seeking and the risk reducing parts of their portfolio.”
Her main recommendation to Australian investors was to be aware of the large potential for purchasing mortgage backed securities from the US.
“Since the crisis the government backed entities have essentially provided 100 per cent of financing to mortgage borrowers. Now the government is pulling away from lending to large mortgage providers, there is demand for private lenders [to step in].”
One innovation in mortgage backed securities is for risk sharing bonds where the performance is directly tied to the default risk of the underlying borrowers.
Martier calculated that 54 percent of institutional investors in the US were invested in such types of private credit and a further 13 per cent were considering it. Some of the money from these deals is being reallocated from fixed income and some from private equity.
Jim Cielinski, global head of fixed income at Columbia Management and Threadneedle Investments, highlighted how investors needed to rethink the role of fixed income given the real yield of government bonds was at 1-1.5 per cent and such assets no longer performed their desired role of hedging an investor’s biggest risks.
He said the current dysfunction in fixed income portfolios was partly the fault of fund managers. “Fixed income managers have been pretty lazy, they have been long beta more than anything else. That is not the product design that is going to work going forward,” he told delegates.
He argued for fixed income managers to use a greater range of tools and proposed the beta of fixed income to be managed through the interest rate cycle and for portfolios to be restructured to give managers a more flexible opportunity set, particularly in the freedom to allocate between different types of fixed income.
He also cited that statistics showed investors would have a bigger chance of underperforming if they leave their allocations static for five years, not least because with yields at rock bottom levels he predicted the credit cycle would start to turn between 2015-2018.
There was also a warning that with yields unable to fall much lower this was not good news for equities, which had benefitted from investors moving out of fixed income. “You cannot just jump into another cash flow which is sensitive to fixed interest yields rising,” he said.