Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Manager selection in multi-sector fixed income
Multi-sector fixed income strategies are looking increasingly attractive as investors grapple with the implications of the global interest rate landscape. Manager selection is not so easy.
A client paper by global manager search and research firm bfinance, titled ‘Multi-Sector Fixed Income: Back in Focus‘, details the complexity of the asset sub-class mix, even with the different terms used to describe each of the moving parts, and diversity of offerings.
The paper notes the strong interest in manager searches in Australia and New Zealand as well as globally as asset owners seek managers which eschew single-strategy benchmark-relative approaches in an effort to capture returns opportunistically and/or provide downside protection.
“The complexities of the asset class, however, cannot be overstated. There is no agreed definition of what actually constitutes a multi-sector fixed income product or fund and strategies come in many guises with different components and risk profiles,” bfinance says.
“Allocation to sub-sectors like sub-investment grade and emerging market debt, as well as structured credit can, in principle, offer improved yields and diversification benefits. In some cases, these categories may be sectors that an investor would struggle to allocate to on a standalone basis due to minimum investment size thresholds or constrained in-house resources.”
The firm has come up with its own groupings of managers, the number of which has mushroomed since the global financial crisis, to assist its own investor clients, which the industry could do well to adopt to help with standardisation. They are:
- Absolute return – targeting returns of 1-3 per cent a year and expected volatility of 0.5-4 per cent
- Broad diversified – targeting returns of 3-6 per cent and volatility of 6-8 per cent, and
- Leveraged finance – targeting returns of 3-10 per cent with volatility of 3-10 per cent.
The fee scales tend to reflect the degree of risk, as with other asset classes, starting with a range of 30-50bps for ‘absolute return’ through to 50-77bps for ‘leverage finance’ strategies. A bfinance search can involve as many as 200 candidate managers.
Kunal Chavda, bfinance director of public markets, fixed income, said from London last week (July 7) that it was important to spend time with the client at the outset of such a search to understand why they wanted to do it, their appetite for risk, where they wanted it to fit in the total portfolio and other considerations.
“You can take categorisation to the nth degree. It’s more of an art than a science,” he said. “If you take the eVestment global unconstrained fixed income universe, but a lot of strategies are not captured in that… We’re looking for strategies that can allocate across multiple types of securities and have multiple duration levers. The universe is quite a bit wider.”
From an individual investor’s perspective, bfinance would like to know, for instance, whether the client wants to include emerging market debt strategies and what sort of currency risks it is happy to take.
“When we are looking for different types of strategies we try not to double up [on what is already in the portfolio],” Chavda said. “We also think about the changing environment; for instance, in sharp falls, correlations tend to merge.”
Frithjof van Zyp, bfinance’s Sydney-based Australasian director, said the fact that multi-sector fixed income was not an homogenous asset class, tended to fit with a client-focused approach to the manager searches.
He said that, in Australia, the firm had performed searches for an absolute return-focused strategy and, earlier this year, one for high-yield and bank loans. In both cases some Australian managers were among the candidates.
Something else for investors to watch, as with other emerging asset classes and popular new strategies, is whether the manager is truly qualified for the task. As with ESG-focused and impact investing offerings, for which the term ‘greenwashing’ has been used to describe disingenuous managers whose credentials don’t stack up on closer examination, some will exaggerate their capabilities and reach with multi-sector fixed income.
Chavda said that bfinance wanted to know why the manager was allocating to the strategy and whether it had genuine capabilities. “Mostly managers don’t over-stretch but sometimes we see it,” he said. Securitised debt, for instance, required a specialised skill set with the multi-sector fixed income groupings.
Fixed income has widely adopted ESG principles – admittedly not as quickly than in equities management – as shown in a recent bfinance survey of 256 global investors. This showed that 64 per cent are now applying ESG considerations to their fixed income portfolios, up from 29 per cent about three years ago.
