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Unconstrained bond funds amid rising rates

Are unconstrained bond funds proving their worth in the rising rate environment?

Bryan Goh, Bordier & Cie (Singapore)

Chief investment officer
Unconstrained bond funds are hard to analyse, because they lack a benchmark. In our selection, we seek low correlation with traditional bond markets, i.e. duration and credit spread.

One issue we have with unconstrained bond funds is their usually very low volatility, which makes them capital inefficient. Also, it is difficult to find one manager who is an expert in all the various credit markets.

We prefer to allocate specifically to individual managers who are experts in their field. In this environment of rising rates and leverage, we allocate to funds of CLOs from first loss to BBB to agency mezzanine mortgages and to leverage loans, to name a few.

The granularity and transparency of this approach allows us to run macro overlays, such as curve trades and sovereign spread trades.

 

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Bryan Goh, Bordier & Cie (Singapore)

Chief investment officer
Unconstrained bond funds are hard to analyse, because they lack a benchmark. In our selection, we seek low correlation with traditional bond markets, i.e. duration and credit spread.

One issue we have with unconstrained bond funds is their usually very low volatility, which makes them capital inefficient. Also, it is difficult to find one manager who is an expert in all the various credit markets.

We prefer to allocate specifically to individual managers who are experts in their field. In this environment of rising rates and leverage, we allocate to funds of CLOs from first loss to BBB to agency mezzanine mortgages and to leverage loans, to name a few.

The granularity and transparency of this approach allows us to run macro overlays, such as curve trades and sovereign spread trades.

 

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Andrea Ciaccio, AZ Investment Management

CEO

We are not invested in unconstrained bond funds. We certainly advocate an active exposure to fixed income, considering the inherent inefficiencies of the reference indices.

We also agree that the asset class can no longer be considered “safe” in a rising rate environment; however, we prefer to pick and choose our exposures within a global investment universe by investing in simple, transparent, dedicated traditional bond funds that have more clearly defined risks and drivers of returns.

 

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Cynthia Lai, JP Morgan Private Bank

Executive director of managed solutions and portfolio management group

A number of unconstrained bond funds have disappointed investors with a negative performance this year. However, this has to be viewed in a broader context of how markets have performed.

We are invested in some unconstrained fixed income strategies, but not all. Unconstrained fixed income strategies are not all made equal.

The decision to invest depends on the investment objective of the strategy, the flexibility of the investment mandate, the investment strategy adopted to achieve returns, types of asset classes the strategy can invest in, how well thought-out the portfolio construction is and whether all of that is aligned with how we view the markets and more importantly whether it is aligned with clients’ investment objectives.

 

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Arnulfo De Pala, Trilake Partners

Chief investment officer

We can use the usual quantitative tools to give an appropriate portfolio weight to a traditional bond fund based on its credit quality, expected duration, geographic concentration and other known features.

However, we cannot easily do that with an unconstrained bond fund, because the actions and positions of the fund manager are unknown.

We don’t really know how well it will work within a particular portfolio - it’s effectively a bet on the skill of the bond fund manager.

By that logic, I would then rather find a manager with a bigger toolbox and larger alpha potential and that could very well be a hedge fund manager doing fixed-income arbitrage, structured credit or just monetising macro views through bonds and currencies. There are other ways to mitigate duration risk if the primary motivation is to switch into these products.

 

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Daryl Liew, Reyl Singapore

Head of portfolio management

While unconstrained bond fund managers have a greater degree of flexibility in positioning their portfolios, the difficult market conditions have meant that most of these funds are registering losses for the year.

These poor results have corroborated our overall underweight stance on fixed income in our portfolios, preferring to be overweight cash instead. We do have one unconstrained/absolute return bond fund on our buy list - the M&G Optimal Income fund - which has a good long-term track record, and at the time of writing, has just broken into the black on a year-to-date basis.

The fund’s performance has hovered in a relatively narrow range between -1.3% to +1.1% this year, which is acceptable, in my opinion, considering the market conditions.   

 

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