“Unconstrained bond funds can deliver attractive returns despite an investible universe in which almost a third of government bonds are paying negative yields,” Patricia Schuetz, senior client portfolio manager at Pictet Asset Management told FSA during a recent visit to Hong Kong.
“Their investment strategies look beyond short-term noise, aren’t restricted by benchmarks, can invest across all global government and corporate bond markets and can be used to mitigate risk as well as capture opportunities for positive returns,” she said.
The concept is not new, and fund managers have been keen promoters of unconstrained strategies since the start of the year in response to uncertain official interest rate policies and shifting investor sentiment.
Pictet has two funds, available to accredited investors in Singapore, that adopt this unfettered approach, both managed by Andres Sanchez Balcazar and Thomas Hansen. The more conservatively-run $1.8bn Absolute Return Fixed Income Fund was launched in 2012, and targets 3-4% over US libor each year within an annualised volatility range of 4-6%.
It has generated 7.5% cumulative return over the past three years, according to FE Analytics data, but its annualised return of 2.43% is below its target. On the other hand, its volatility is just 1.57% – which suggests that the fund could take on more risk to boost returns.
The racier $254m Global Fixed Income Opportunities Fund was only launched last year, and has a more ambitious return target of 6-8% a year over cash, and expects volatility of 6-10%.
Although the two funds have different risk-return profiles, they have the “same investment team, same investment principles, same investment process and same focus on risk,” said Schuetz.
In effect, they “balance risk-on with risk-off positions”.
This strategy seems similar to the one Legg Mason’s Amanda Stitt described for the firm’s unconstrained bond strategy.
Stitt told FSA earlier this month that half the portfolio is allocated to high yield bonds and carry positions, and the other half is invested in 20-year US Treasuries. The idea is that the high conviction, riskier exposure is mitigated by the security of long duration government bonds.
“Basically, it has adopted a barbell strategy,” said Stitt.
However, Schuetz insisted that Pictet’s portfolio configuration is not a barbell strategy, which is typically defined as a portfolio comprising a mixture of short-dated and long-dated bonds, with nothing invested in intermediate bonds.
Instead, in a three-stage process, the Pictet managers identify a few long-term structural themes, devise strategies that offer value based on the three conventional alpha sources of rates, spread and foreign exchange, and then build a stress-tested diversified portfolio.
“The themes include an extended period of low interest rates, continued crises in the Eurozone, Japan’s failure to reverse deflation or resolve its public debt and demographic problems, and slower Chinese economic growth,” said Schuetz.
Portfolio construction
Addressing the scenario of protracted low rates, the funds’ risk-on positions are long non-financial corporate bonds, short duration in Hungary, and long yield curve steepening in Poland and New Zealand. The counter-veiling risk-off position is a large allocation to long-dated US Treasury bonds.
Predicated on continued problems in Europe, the fund is long European senior and subordinated bank debt, long European property issues and long peripheral European government bonds. Its corresponding risk-off holdings are long-dated German, French and UK government bonds.
The Chinese transition theme is represented by holdings of hard currency emerging market sovereign issues, hard currency Chinese corporate bonds and allocations to local currency Indonesian, South African and Mexican rates, while risk-off is represented by shorting a few other emerging market currencies and a long, defensive position in Japanese yen.
“Unfortunately, the managers can’t find a way to reflect their expectations of the failure of Abenomics in Japan in their portfolios,” said Schuetz.
Although the two funds are “unconstrained”, they have self-imposed limits of 0.6% for high yield issuers, 2% for corporate investment grade issuers and 10% for an emerging market issuer. In addition, the Absolute Return Fixed Income Fund can only hold up to 50% of its net asset value in high yield and emerging market bonds, while the Global Fixed Income Opportunities Fund has a 75% cap on these riskier securities.
As of the end of July the Absolute Return Fixed Income Fund held a cash position of 11.7% and the Global Fixed Income Opportunities Fund had a 6.1% cash holding.
“These higher than normal cash levels resulted from profit taking following a strong rally and should be lowered once we identify the appropriate investment opportunities. We target to stay fully invested but we will not be buying simply for the sake of buying, and we’ll always focus on value when we do invest,” said Schuetz.
Pictet Absolute Return Fixed Income Strategy
Source: Pictet Asset Management
Pictet Global Fixed Income Opportunities Strategy
Source: Pictet Asset Management
Pictet Absolute Return Fixed Income Fund vs benchmark and sector average
