In a timely series of meetings with advisors and bigger investors in Australia last week, Payden & Rygel, the US-based global fixed income manager, provided an interesting overview of the difficulties being faced by investors looking for yield and downside protection.
Fresh from the previous week’s announcement of a major mandate win with Rest – a $500 million absolute returns fixed income strategy which focuses on downside protection – Payden & Rygel’s Eric Souders, a principal and portfolio manager, and Ali Giles, a principal and head of corporate research, posed the question: “where do we go from here?”
Payden & Rygel, represented in Australia by GSFM, has a strong background in short-duration securities, although it has tended to broaden its strategy options in recent years, according to Giles. The privately owned firm was started in 1987, itself a difficult year for markets given the stock market crash and soaring interest rates. It has about US$120 billion under management, about US$12 billion of which is in the absolute return fixed income strategy, targeting a spread of 2-3 per cent above cash. It also uses tactical overlays and beta hedges to assist downside risk control.
Souders said that, heading into and during the global financial crisis of 2008, absolute returns strategies tended not to do what they had promised, in terms of protection. “And in some ways, they still don’t today,” he said. Payden & Rygel has examined all the options, including risk premia and liquidity premia, to find a better way to preserve capital over shorter time periods. What the firm has come up with, he refers to as “a constrained version of unconstrained”. There are various “guard rails”, such as through duration and emerging market debt exposures.
“This is not a macro long-short strategy,” he said. “It’s based on good research for long-term income streams. We want core income to drive returns, not tactical shifts. You need some form of insurances, such as hedges, to preserve the income. Tail-risk hedging has provided protection against extreme market conditions.”
The firm observes that the absolute return investing universe has represented a variety of investment objectives and approaches through time. “Even today, the term is used by both hedge funds, on one end of the spectrum, as well as ultra-safe, liquidity-type funds, on the other. While the space has yet to be concretely defined, the development of our strategy began with a simple client request to manage a portfolio, untethered from traditional benchmarks, that would produce as reasonable level of return and protect the investment principal.”
Before the portfolio managers consider the direction of markets or the value opportunities that are presented, it sees its first responsibility as protecting the investor’s principal against the potential for loss. Risk management is paramount.
The ‘Payden Absolute Return Investing’ approach has been refined over the past 11 years. The foundation of the strategy is a low-duration fixed income portfolio where risk premia from global interest rate curves and credit markets provide dependable and repeatable returns.
Damien McIntyre, GSFM’s chief executive, said at a Sydney advisor briefing that that the manager selection decision in the current environment would be critical.