Fixed income investments can be used to hedge against equity risk but only when they are made in high-quality government bonds, Whitehelm Advisers principal adviser Debbie Saunders says.
Saunders says that although fixed income strategies are traditionally seen as defensive, and therefore ideal as an equity hedge, falling bond yields and an increasing shift toward other fixed income exposures have made such strategies less definitive. Whitehelm is an institutional asset consultant with more than $17 billion in funds under advice.
“If it’s not giving you a positive uplift when there’s market stress, then it’s not a defensive asset,” Saunders says. “And if the purpose is for the investment to be an equity hedge, I’d suggest it wouldn’t be effective in this way; however, if the purpose is to be a different driver of returns, then this can probably achieve that.”
To this end, some institutional investors lack clarity in the way they disclose their fixed income investment strategy, Saunders says. While the investor’s intention might be to have a defensive fixed income strategy, it can be countered by for the need for higher returns.
For example, there’s an increasingly popular trend among investors to invest in the high-yield bank loan, securitised space, because they are trying to get a level of return they might not be getting from cash rates or bond yields, Saunders explains. Therefore, if a fixed income investment is made in one of these areas, it’s probably not part of a truly defensive strategy, she says.
“You have to look at what people are actually investing in,” Saunders says. “If they’re not investing in government bonds, they’re in other exposures, such as debt securities, with different credit risk profiles.
Generally, the only way to increase returns is to increase risk.”
She adds that while credit might provide a higher return when things are fine in the market, investors will lose money if there’s a downturn.
It’s also worth noting that the investing environment is different now, 10 years on from the global financial crisis, Saunders says. This is leading to decisions that don’t necessarily consider equity risk when investing in fixed income but rather provide a faster road to returns.
“Bond yields are so low that they won’t defend your portfolio today as much as they may have back in 2008,” she says. “The difference today is that because these yields are so low, investors have to do what they can to try to boost returns.”
Debbie Saunders will appear on a panel titled “Can fixed income be used to hedge equity risk” at the Investment Magazine Fixed Income and Credit Forum, taking place at RACV Healesville, Victoria, on July 24-25. For more information, visit the website.