Falling yields have made the debt markets more challenging as investors look to allocate more capital towards bonds and other safe haven assets. This isn’t to say, however, that they’re not hungry for yield and that’s what makes today’s debt market a challenging one when it comes to developing fixed income strategies.
Three experts from investment management firm Invesco offered their opinions on how to approach the debt markets given today’s challenges in a Pensions and Investments article.
“Over the past few years, investors have been stretching for yield,” said Invesco’s Joe Portera, chief investment officer, high-yield and multisector credit. “You can see this across the allocations of most asset owners, whether insurance companies, pension plans or LDI portfolios. Stepping out into the risk spectrum is fine as long as investors are being rewarded for the level of risk they are taking. There seems to have been a decoupling of the risk/reward concept as asset owners reach for yield in a way that may be too aggressive in the context of the entire portfolio.”
Diversification can also come within subcategories of assets like bonds. As such, investors need to be cognizant of diversifying within asset classes.
“Diversification is one of the biggest benefits,” said Jennifer Hartviksen, senior portfolio manager, head of global high yield. “If an investor is able to layer in a few noncorrelated asset classes, the volatility of returns may fall. This is the best way to add risk in a sensible way. “
“A second benefit is the ability and flexibility to expand into other asset classes to take advantage of temporary dislocations,” Hartviksen added. “For example, in 2014 the municipal bond market experienced outflows [that]caused prices to be pushed to extremely low levels. This meant that even without the tax benefit traditionally seen from municipal bonds, the raw yield was very attractive. Due to the flexibility of our structure, we were able to invest 5% of the total portfolio into this asset class, which gave us strong returns for the year in a sector that may have been ignored by most investors.”
One way investors can get exposure to the debt markets is two ways: using a centralized, multisector approach or looking into niche markets.
“A multisector credit strategy is a credit-based strategy, so it will broadly follow the returns pattern of the credit markets,” said Ken Hill, senior portfolio manager. “This type of strategy will have a normal duration range and invest predominantly in fixed-income credit markets. An unconstrained fixed-income strategy will generally have a much wider band for duration (including negative duration in some cases) and will sometimes have an allocation to equities or esoteric securities. In addition, unconstrained will generally have much more volatility as currency, duration and yield-curve bets are expressed in large measures.”
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