SHORT DURATION BONDS

Transcription

1 SHORT DURATION BONDS Our Short Duration Bond Fund range RL Short Duration Gilt Fund RL Short Duration Global Index Linked Bond Fund RL Short Duration Credit Fund RL Duration Hedged Credit Fund RL Short Duration Global High Yield Bond Fund FOR PROFESSIONAL INVESTORS ONLY, 1NOT SUITABLE FOR RETAIL INVESTORS

2 SHORT DURATIOn BONDS The post financial crisis fiscal response has been unprecedented. With vast quantitative easing (QE) measures and interest rates held at 60-year lows, central banks have gone to great lengths to support markets and suppress volatility. With the recovery now gathering pace in many regions, thoughts begin to turn to a return to normality and how to position portfolios for this. 2

3 Uncertain economic outlook QE has pushed bond prices up and driven yields to historically low levels as investors sought safe haven assets. The hunt for yield has turned many investors towards riskier fixed interest assets. Thus far, below target inflation has hampered the government s ability to ease sovereign debt. However, with economic and survey data indicating growth, the prospect of an interest rate rise looms somewhere on the horizon. There has been some divergence in policy between the US and Europe. While the European Central Bank (ECB) has announced greater than anticipated asset purchases, the Federal Reserve s (Fed) QE programme has ended. With the withdrawal of stimulus, an eventual rise in interest rates is anticipated. At RLAM, our view is that we may see a rate rise in the second half of However, with ongoing headwinds to the economic recovery, including an increased sensitivity to the cost of debt and fear of deflation we believe that any change in monetary policy in the UK and US will be very gradual, while other central banks, including the ECB and Bank of Japan (BOJ), will continue with their stimulus programmes. In this scenario, longer duration bond yields will rise with their price falling correspondingly. Including some exposure to shorter duration bonds can help reduce interest rate sensitivity and balance this risk. Strategies with short duration characteristics could therefore offer attractive yields as well as an element of capital protection. Investing for this environment While few commentators predict an immediate rate rise, many believe that it is now almost inevitable and the risk of a quicker-than-anticipated rise is a concern for most asset allocators. Regardless of the extent and pace of interest rate and yield rises, the returns from bonds are likely to be volatile. The taper tantrum that ensued after the Fed s QE tapering announcement hints at potential ongoing volatility in bond markets. In addition, if capital losses prompt outflows from bond markets, liquidity could also become of increasing importance. Typically, periods of economic expansion call for an increase in credit risk relative to interest rate risk. Short duration strategies are typically used by investors who are wary of near term interest rate movements and rising or volatile yields. BOE Base Rate 20 BOE Base Rate Source: Bank of England as at Prior to May 2012 the Official Bank rate was published to two decimal places but has since been changed to four decimal places for consistency. 3

4 Why short duration? Duration is an important tool for bond fund managers. Allowing managers to compare potential price sensitivity across bonds with varying yields, prices and maturities, duration can be adjusted to control portfolio risk. Less exposed to economic cycles, shorter duration bonds can be invaluable in helping manage interest rate risk in particular. The closer the bond maturity, the quicker the principal can be reinvested at a new interest rate, which can be beneficial when interest rates rise, offering potential for a higher yield. It s this protection against interest rate rises that makes short duration bonds so well-suited to current market conditions. Short duration bonds offer protection not just from any hike in interest rates but also from any ensuing increase in market volatility and liquidity challenges that resultant outflows could create, all of which we see as possible outcomes in the coming years. Longer duration bonds - which have a higher sensitivity to rate rises - carry a greater risk of capital loss than short dated bonds. In addition to the aim of reducing interest rate sensitivity, short duration bonds can also offer a number of other advantages: Income as with all fixed interest assets, coupons from short dated bonds address the need for income, an important requirement as the demand for yield remains strong Liquidity short duration bond funds are inherently liquid (relative to longer dated bond funds) given that the bonds within the portfolio are regularly maturing Diversification short duration bonds can produce returns that are less correlated with traditional bond markets, can benefit from inflation and hedge downside risk Reduced costs shorter dated bonds tend to be held until maturity, potentially reducing turnover and associated dealing costs Reduced volatility short duration bonds offer greater price stability and lower volatility than longer dated issues While we believe short duration bonds are well positioned to gain a performance advantage in the longer term, their other characteristics mean that they can play an important role within a well-diversified fixed interest portfolio irrespective of this. 4

5 Our process RLAM s short duration bond funds are managed using a combination of top-down analysis, based on our macroeconomic views overlaid with bottom-up security selection. At the macro level, the process starts with a quarterly economic review during which Ian Kernohan, RLAM s economist offers an assessment of all major economic regions, focusing upon key variables such as growth rates and inflation. This meeting is also used to formulate our outlook scenarios, including short-term, medium-term and long-term yield and interest rate forecasts which underpins our investment strategy. Moving to the micro level, our selection of the individual bonds within the portfolios is driven by our economic views and an assessment of value. To achieve this we use our proprietary relative value model. The output from this model is reviewed daily and used alongside other regression based models to assist with the selection of individual bonds. In addition we also look at stock specific factors that are vitally important. Overall, we aim to construct diversified portfolios with the potential to deliver consistent alpha from multiple sources. Flexibility At RLAM, our value-oriented fixed interest philosophy is based on the premise that credit and sovereign bond markets, to greater and lesser degrees present valuation anomalies that can be exploited. We emphasise our own research and use this to examine a wider investment universe than many of our peers. We believe this presents us with the opportunity to uncover returns that are overlooked by our competitors. Our approach is, therefore, very much an active one. As such, our funds will have the appropriate flexibility to invest tactically in other markets, as appropriate, should any of them present a more attractive investment case than the core asset class. Additionally, having the scope to actively manage the duration of the funds allows our managers to exploit movements in short dated yields. Target yield is not guaranteed and may vary in changing market conditions. Target yield is the expected total income distribution over 12 months as a percentage of the current share price. 5

6 SHORT DURATION BOND FUND RANGE RL SHORT DURATION GILT FUND Craig Inches Senior Fund Manager Overview The duration of the Royal London Short Duration Gilt Fund is actively managed to exploit movements in short dated gilts. It invests in UK gilts while maintaining an overall short duration within the fund. Additionally, the Fund has appropriate flexibility to invest tactically in other markets, such as index linked government bonds, corporate bonds, or non-uk government bonds, should any of them present a more attractive investment case than the core asset class. Benchmark: FTA <5 year Target yield: % Typical duration: Fund manager: 3 years Craig Inches Inception date: Asset allocation Core: Short dated gilts and medium dated gilts Tactical: Cash instruments, overseas government bonds, short dated corporate bonds, short and medium dated UK and overseas index linked bonds 6

7 SHORT DURATION BOND FUND RANGE RL SHORT DURATION GLOBAL INDEX LINKED BOND FUND Craig Inches Senior Fund Manager Overview The Royal London Short Duration Global Index Linked Fund targets the shorter end of the maturity spectrum, aiming to deliver inflation-linked returns with limited interest rate risk. It is an actively managed, globally diversified portfolio with the ability to invest in short dated UK and global index linked government and corporate bonds. The debt securities in which the Fund invests may be investment grade or non-investment grade. Benchmark Target yield: Typical duration: Fund manager: 50% Barclays UK 1-10year inflation linked bond index, 50% Barclays 1-10year inflation linked bond index (GBP hedged) Benchmark +0.5%p.a. over rolling 3 year period 5 years Craig Inches Inception date: Asset allocation Core: Short dated UK and overseas index linked government bonds Tactical: Cash instruments, short dated UK and overseas government bonds, short dated index linked credit 7

8 SHORT DURATION BOND FUND RANGE RL SHORT DURATION CREDIT FUND Paola Binns Senior Fund Manager Overview The Royal London Short Duration Credit Fund targets shorter-dated bonds (up to 5 years maturity) in the sterling investment grade credit market that we believe currently offer value. Fund duration is actively managed. The fund may have tactical allocation to other asset classes, such as gilts and index-linked bonds. Benchmark: BofA ML 1-5 year Sterling Non Gilt All Stocks Index Target yield: % Typical duration: Fund manager: 3 years Paola Binns Inception date: Asset allocation Core: Short dated UK credit Tactical: Cash instruments, short dated gilts, medium dated UK credit, short dated overseas credit 8

9 SHORT DURATION BOND FUND RANGE RL DURATION HEDGED CREDIT FUND Paola Binns Senior Fund Manager Overview The Royal London Duration Hedged Credit Fund invests in investment grade corporate bonds across a range of maturities, although it may also invest in UK government and other debt securities and uses derivatives to protect against interest rate risk. Duration is actively managed to reflect the manager s views of interest rates with a target duration of zero years. Benchmark: 3 month LIBOR Target yield: % Typical duration: Fund manager: 0 years Paola Binns Inception date: Asset allocation Core: UK and overseas credit, UK gilts (held as collateral against interest rate swaps) 9

10 SHORT DURATION BOND FUND RANGE RL SHORT DURATION GLOBAL HIGH YIELD BOND FUND Azhar Hussain Head of Global High Yield Overview The Royal London Short Duration Global High Yield Bond Fund invests a large portion of its assets in short maturity sub-investment grade bonds issued by companies domiciled in the UK, Europe, Africa, Asia and the Americas. The Fund may also invest in short maturity investment grade securities. It may also invest in short maturity bonds issued by European governments and government related agencies. Benchmark: 3 month LIBOR Target yield: LIBOR + 4.0% Typical duration: Fund manager: Less than 2 years Azhar Hussain Inception date: Asset allocation Core: short dated high yield bonds Tactical: Cash instruments, short dated UK and overseas government bonds 10

11 CONTACT For further information about any of our products or services, please contact: Royal London Asset Management 55 Gracechurch Street London EC3V 0RL Tel Fax For professional investors and advisors only. This document may not be distributed to any unauthorised persons and is not suitable for retail clients. This document is for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Nor does it provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. These funds can invest more than 35% of their value in government securities. Unlike the income from a single fixed income security, the level of income (yield) from a fund is not fixed and may go up and down. Sub-investment grade bonds have characteristics which may result in a higher probability of default than investment grade bonds and therefore a higher risk. For funds that use derivatives, their use may be beneficial, however, they also involve specific risks. Derivatives may alter the economic exposure of a fund over time, causing it to deviate from the performance of the broader market. Issued by Royal London Asset Management May Information correct at that date unless otherwise stated. Royal London Asset Management Limited, registered in England and Wales number ; Royal London Unit Trust Managers Limited, registered in England and Wales number RLUM (CIS) Limited, registered in England and Wales number All of these companies are authorised and regulated by the Financial Conduct Authority. All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number Registered Office: 55 Gracechurch Street, London, EC3V 0RL. The marketing brand also includes Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between subfunds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number Registered office: 70 Sir John Rogerson s Quay, Dublin 2, Ireland. Our Ref: 405-PRO-04/2015-JW. 11