Home / Unconstrained fixed income – who would have thought

(pictured: Robert Abad)

Most of the action in investments at the moment is in fixed income, believe it or not, as managers look to offer traditional bond-like risk/return characteristics in the most hostile environment for bonds in history. The way to go for investors is to take the constraints off their managers.

Western Asset Management, the US-based global manager, has launched an Australian-domiciled unit trust for its ‘Macro Opportunities’ strategy which has generated a 13 per cent annualised return since 2012, when it was launched as a fund, and with a Sharpe ratio of 1.0, which is very high.

The strategy actually dates back to 2000 when Western began taking fixed income mandates from big institutions into the more creative space of credit and various other debt instruments.

According to Robert Abad, an emerging markets debt specialist and research analyst at Western Asset in Pasadena, California, investors are looking for a return which doesn’t have any equity beta.

On a visit to Australia last week, during which he spoke at the Conexus absolute returns conference, Abad said that the narrative with fixed income had switched from the search for yield to one of risk management. Investors had become uncomfortable with the risks associated with their fixed income benchmarks.

He says: “In a break with the past, the thesis for investing in emerging markets should not take shape around the higher rates of expected growth in those countries [compared with] the developed world… Rather, in a market characterised by uncertainty and concern over rising sovereign debt risk, the more compelling rationale for investing in emerging markets today centres on the improved debt sustainability metrics these nations now enjoy.”

Western Asset, which is an affiliate manager of Legg Mason, has produced a paper…….download PDF…. titled ‘The Benefits of Unconstrained Investing’. As all good quants know, the less constraints the greater the opportunity to outperform. But then there’s the issue of risk. And what does ‘risk’ mean? Therein lies the rub.

Abad says that when you introduce new securities or take more concentrated bets in the portfolio, and when you give up on your guidelines, you get more diversification. It’s a matter of managing a risk-on portfolio alongside a risk-off portfolio.

The Western Asset style is fundamental value, notwithstanding the higher alpha it has generated. “We are not forced to sell in the bad times,” Abad says.

Like most global bond managers, Western Asset gets a lot of its return from currency management. In the recent past the firm has been short the yen and, to a lesser extent, short the euro. More importantly, Abad says, he has been short the RMB (Chinese yuan). Long positions include Brazil, India and Russia.

“While the long positions can perform, we believe, our short on China will offset any risks associated with that,” he says.