Managing higher volatility has become much tougher with interest rates at such low levels since any change will lead to greater convexity, according  to three panellists speaking at Investment Magazine’s Fixed Income and Credit Forum.

“Given the volatility of fixed income, given how low rates are – and how small changes can mean very large changes in valuation – this has enormous implications for fixed income as an asset class and as a defensive asset,” Ben Alexander, chief investment officer, Ardea Investment Management said.

The panellists touted the use of relative value approach to fixed income investment and tracking error measures as a way to capture returns during volatile times.

Alexander said using a relative value approach allowed him to take advantage of any mispricing in the market from volatility.

“A relative value strategy can almost deliver absolute return like returns,” he said. “It also offers defensive characterises and an uncorrelated approach. Volatility doesn’t affect this strategy – you don’t have to have any expectations of where rates will go or how macro-economic conditions will change.”

Alexander went on to say that two securities could have similar risks but different prices.

“The point of relative value is that when they deviate from the norms, we take advantage of the small deviations,” he said.

The CIO said the current environment had thrown up plenty of constrained opportunities. On the defensiveness of duration, he said while it was clearly the first line of defence it doesn’t work all the time.

Jason Huang, portfolio manager, research and governance at ANZ Private Bank, said he expects the value of bonds will rise by a lot more in a low-rate environment. He  also underlined the usefulness of tracking error measures to explain potential deviations of bond fund performance relative to the benchmark.

For George Lin, senior investment manager at Colonial First State Investments, liquidity will be harder to manage going forward. “It can be a function of market volatility,” he said. “High market volatility and correlations to equities will also be harder to manage. It’s difficult, you can’t always tell what’s happening when you are dependent on mangers assessment of this.”

All three panellists agreed that now is the worse time to take a conventional approach to fixed income investment because portfolio managers are getting less return for the risk.

 

Elizabeth Fry has been a financial journalist for more than 25 years and has written for a number of publications, including CFO, The Financial Times and The Australian Financial Review.
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