Chris Bowie

Investors are expecting too much from unconstrained fixed income managers and trade-offs need to be made according to Robert Moore, head of fixed interest at JANA.

“Arguably investors have asked their managers for too much – an unconstrained approach that gives them return and defensive elements,” he said. “It is hard to return cash plus 3 per cent and be defensive; this has led managers to invest in areas like emerging market debt which are not defensive. So the biggest flaw of unconstrained is that without any constraints they’ll be built on a yield or return target. But they can’t create miracles – there are no strategies that give that return, be defensive, and have no drawdowns.”

But Chris Bowie, partner and portfolio manager at London-based TwentyFour Asset Management, said there is another way to leverage the asset class, by having a different conversation with managers.

“Don’t constrain, or unconstrain, them by asset but by volatility. They will see a different way of allocating that can improve risk adjusted returns,” he says. “If you have that different conversation with your manager, they will need to do a lot of work and it changes the mindset to be constrained by volatility.”

Bowie agreed there are too many levers in unconstrained fixed income strategies, but if the manager is constrained by volatility, they can manage the Sharpe ratio, and he said the best way to do that is to invest in short duration BBBs.

“Investors use unconstrained to try and find some yield; income remains a precious commodity. Investors should be allocating to benefit from the managers skill set but the problem has been a lot of volatility, that can exceed investors’ expectations. The results have not quite matched expectations,” he said.

But Bowie says by managing volatility, through investing in short duration BBBs, the manager can manage risk-adjusted returns.

“Even in years like 2008 you can keep volatility low in short-dated BBBs. We have found if you have 67 per cent of the portfolio in short-dated BBBs it can manage the Sharpe ratio. This really surprised us that even in difficult years you can find areas of fixed income that can produce positive returns.”

Bowie said that the yield and roll down more than offset the capital volatility, and that in the past few years AAAs have been more volatile and have lost more capital than BBBs.

“I think BBBs are no more likely to default today than any other time in the last 100 years,” he said of the risks.

JANA’s Moore said the consultant defines unconstrained fixed income strategies in to three main areas:

  • Market neutral, quant influenced, relative value strategy – these are truly uncorrelated but finding such strategies that are open and good and relatively inexpensive is difficult.
  • Short duration high quality credit – this gives one of the most attractive risk reward tradeoffs
  • Macro based multi sector truly unconstrained go anywhere strategy – this third type that has struggled over recent years particularly last year.

He said part of the reason for the struggle in the past few years has been the obvious trades didn’t work, so directional strategies on inflation, duration, and credit were not rewarded and impacted by significant idiosyncratic events over the year.

“Going forward the environment for these strategies could continue to be challenging. Investors need to accept a trade-off in risk and return does exist. We say there should be a mix of strategies.”

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