Investors should temper their expectations from absolute return fixed income strategies, with a range of cash plus 2 per cent to 3 per cent realistic in the current market, Avant Mutual chief investment officer John Lucey says.

Lucey also emphasises that manager selection in this segment of fixed income is paramount.

Avant is a medical indemnity insurer, with $2.15 billion in net assets, $800 million of which is in interest rate-sensitive bonds and cash, the fund’s 2017 annual report states. The firm has a dedicated allocation to absolute return bonds within its portfolio, which is spread over a number of managers. It has been investing in the sector for more than seven years.

Manager selection critical

Given that absolute return managers are less dependent on the direction of the market, Lucey says investors must be aware that no two managers are the same and choose carefully.

“Absolute return fund managers should not be correlated because it comes down to idiosyncratic risk,” Lucey explains. “You can’t just go out and buy a benchmark because it doesn’t exist. [Individual] manager skill is critical in this asset class.

“Whether it’s in bonds, rates, credit, high-yield, emerging market debt or currencies, absolute return strategies get a return by pulling a number of different levers. That’s where the complexity comes in. But you should be able to get better returns over the long term, due to these more diverse return drivers.”

Why absolute returns now

Lucey says the reason absolute return strategies have become more popular of late is because credit spreads are tight and yields are low.

“Money has been made out of the duration and because spreads have compressed and it’s been a good environment,” Lucey says.

Fixed income strategies have grown more sophisticated, however, requiring a greater level of risk management. As such, absolute return bond managers are focused on capital preservation and use advanced risk systems to identify, manage and mitigate individual risk factors to keep them from overwhelming the portfolio.

“They’re very risk averse in relation to losing your capital,” he says. “This is achieved by investing in a wide variety of global fixed income assets in a flexible and dynamic way.”

John Lucey will be speaking at the Conexus Financial Fixed Income and Credit Forum on July 24-25 at the RACV in Healesville, Victoria.