Why Strategic Bond funds are failing investors

Transcription

1 Why Strategic Bond funds are failing investors March 2016 For Professional Investors only

2 The rise of Strategic Bonds The IA Sterling Strategic Bond sector was launched to much fanfare in The birth of the sector partly reflected the fact that a few The appetite for strategic bond funds has been fuelled by exceptionally powerful marketing messages from the fund providers; Fixed income is a complex asset class, funds at the time were already adopting an covering a huge range of bonds with very unconstrained approach to fixed income different risk and return profiles. Do you investing. It also reflected the growing demand invest in fixed or floaters? CoCos or from fund buyers for products that could operate convexity? Duration or distressed debt? outside of the traditional fixed income sectors of gilts, investment grade corporate bonds or high yield bonds. Strategic bond funds have been phenomenally successful at attracting inflows since 2008, with the sector climbing to become easily the second largest bond sector, behind only the IA Corporate Bond sector in terms of assets under management. Invest in an unconstrained bond fund, where you can outsource this complexity to the experts. Unconstrained bond funds can use their freedom to potentially generate positive returns in any part of the economic cycle, even when interest rates or inflation are rising. Strategic bond funds can be your one stop shop. In short, whatever happens, these funds will perform. Do you invest in strategic bond funds? Yes No See results

3 How they are failing... Strategic Bond Funds have been hugely popular with investors garnering significant flows and attention. However, we believe they are failing investors.

4 How they are failing... Strategic Bond Funds have been hugely popular with investors garnering significant flows and attention. However, we believe they are failing investors. The reality has been very different. In fact, if you take the average return of the main IA bond sectors, while the strategic bond sector has performed well in absolute terms, they have actually been the worst performing sector, not the best as you d probably have expected. IA Fixed Income Sector Returns It may be a little unfair to look at the average fund in strategic bond sector, given that there are a number of funds in the sector that are not strategic in their style and are in the sector simply because they don t fit into any other sector. And, while the average return may be relatively mediocre, it s true there are a number of strategic bond funds that have performed exceptionally well since 2008 up until Are you concerned with the performance of the strategic bond funds you use? Yes, very much so Yes, a little No, not really No, not at all See results Source: IA and Allianz Global Investors, as at Past performance is not a reliable indicator of future results.

5 However, even for the large and successful funds, drilling down into where these returns have come from reveals that they are not really strategic, and they re not making use of the flexibility that the sector allows. Instead it seems that all of the big funds in the sector are simply corporate bond funds with a high yield kicker, and do little more than tilt the portfolio one way or the other. This can be evidenced by looking at the correlations of the biggest funds with the longest track records against a variety of fixed income asset classes. I believe that most Strategic Bonds funds have failed to deliver what they promised. While the concept is a sound one, the performance of many of these funds has been disappointing for investors The correlation analysis uses two year rolling averages looking at the largest strategic bond funds in the sector, and demonstrates the high correlation with high yield bonds in particular. In fact over the period as a whole, every fund had a correlation greater than +0.8 with high yield bonds, with one fund incredibly showing a correlation of What may be particularly concerning for investors is the strong correlation that these funds have demonstrated versus the FTSE All Share, given that many people would want the fixed income portion of their portfolio to offer diversification versus any equity holdings held within a balanced portfolio. Mike Riddell, Fixed Income Portfolio Manager

6 BofA ML Sterling Corporate & Collateralized Index Strategic Bond Fund Correlations BofA ML Sterling High Index Strategic Bond Fund Correlations Source: IA and Allianz Global Investors, as at Past performance is not a reliable indicator of future results. Source: IA and Allianz Global Investors, as at Past performance is not a reliable indicator of future results.

7 FTSE All-Share Strategic Bond Fund Correlations Further evidence of strategic bond funds big bias to always being long of credit risk can be found in the performance of the sector in January and February Gilts returned over 5% in the first two months of the year, the 5th biggest two month rally this millennium, and yet three quarters of strategic bond funds experienced negative returns. This was due to their exposure to high yield bonds, which fell around 2%. Investment grade corporate bond returns actually succeeded in generating a marginally positive return over the period. Source: IA and Allianz Global Investors, as at Past performance is not a reliable indicator of future results.

8 The next generation of strategic bond funds Given all the evidence against Strategic Bond Funds, is the concept finished?

9 The next generation of strategic bond funds Given all the evidence against Strategic Bond Funds, is the concept finished? Or should investors look towards the next generation of strategic bond funds This is not to say that there is anything wrong with the concept of a strategic bond fund. Quite the opposite - used in the right way, unconstrained investing is essential for fund managers to generate alpha versus a predetermined benchmark. The problem is that no strategic bond funds are using anything like the degree of flexibility that the IA Strategic Bond was designed for. The next generation of strategic bond funds needs to generate returns by using the following strategies: Going global. As long as a strategic bond fund has at least 80% of its assets hedged back to sterling, a fund can make full use of the opportunities outside of UK or European corporate bond markets Use FX. While at least 80% of a fund must be in sterling, funds are permitted to use a wide range of FX overlay strategies. We think the global currency wars have only just begun, and FX is the asset class likely to offer some of the biggest opportunities. Just consider how much money strategic bond funds have missed out on in the last few years given the moves in the US Dollar, euro, Japanese Yen, EM currencies and commodity currencies. Use duration, but properly. Duration has always been an important tool for fixed income fund managers, but almost all strategic bond funds have been permanently short duration post the 2008 crisis, which has been a disaster for performance. Furthermore, duration is just one blunt way of managing a fund s beta, it s possible to use many instruments to profit from yield curve dislocations across a large number of markets. Take views on inflation. Some funds have invested in inflation linked bonds as a way to benefit from inflation rates rising. But not only have these views been wrong, it s also the tip of the iceberg in terms of ways to express inflation views. Many instruments exist to express not only inflationary but also deflationary views across a wide range of countries Invest in credit but very selectively! Corporate bonds can be a good potential source of returns (eg , ), but buy credit when it s cheap, don t own it when it s not. And if it s expensive, you can express bearish views on individual companies, and also take a bearish view on corporate bonds as an asset class overall A strategic bond fund should be making use of all these strategies. What s more, using the full opportunity set available means that not only can a strategic bond fund provide investors with superior returns, but also returns that aren t highly correlated to high yield bonds and equities.

10 Do you feel that Strategic Bond Funds need to take a more flexible approach using a wider toolkit of investment options? Yes No See results Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. The volatility of fund unit prices may be increased or even strongly increased. Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor s local currency. This is for information only and not to be construed as a solicitation or an invitation to make an offer, to conclude a contract, or to buy or sell any securities. The products or securities described herein may not be available for sale in all jurisdictions or to certain categories of investors. This is for distribution only as permitted by applicable law and in particular not available to residents and/or nationals of the USA. The investment opportunities described herein do not take into account the specific investment objectives, financial situation, knowledge, experience or specific needs of any particular person and are not guaranteed. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or wilful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail. For a free copy of the sales prospectus, incorporation documents, daily fund prices, key investor information, latest annual and semi-annual financial reports, contact the management company at the address indicated below or Please read these documents, which are solely binding, carefully before investing. This is a marketing communication issued by Allianz Global Investors GmbH, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht ( Allianz Global Investors GmbH has established a branch in the United Kingdom, Allianz Global Investors GmbH, UK branch, 199 Bishopsgate, London, EC2M 3TY, which is subject to limited regulation by the Financial Conduct Authority ( Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.

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