Despite the low-yield environment, fixed income continues to play an important role for institutional investors looking to make their portfolios work harder in a risk-controlled fashion, said Jeffrey Moore, a portfolio manager at Fidelity Investments Inc., during a session at the Canadian Investment Review’s 2021 Global Investment Conference.
“For the bond market to hurt, there needs to be something big happening. You don’t see a lot of negative returns because the bond market, in general, resets its coupons pretty quickly. You’ve got really good chances of a positive return; partly because you’ve got yield and, oftentimes, it’s more than enough to offset price downsides that can happen.”
Moore cited the example of U.S. treasury bonds, which rallied during a recent stock market dip. “If you look at U.S. treasuries, they’re basically negatively correlated stocks. They have volatility of five to six per cent [and], even if you don’t like the yield, still play a role as a diversifier. Consequently, having those bonds in your portfolio gives that extra bit of protection and gives you something very liquid when stocks have a drawdown.”
Conversely, high-volatility sectors such as high-yield bonds and emerging market debt can produce massive tails, a factor that investment managers need to take into consideration when buying these products, he said.
Moore also stressed the importance of benchmarks for investors. He advised asset holders to ensure that multi-sector managers understand the identifiable volatility to help establish beta and its role in portfolios.
“I’d want a benchmark with some volatility and some tails that you can get comfortable with as a client. If you decide to give your multi-sector manager some flexibility, the first question you’ll get is, ‘How much beta do you have?’ When you go to multi-sector, you’re going to open up the beta range a little bit, but you want your manager on a pretty short leash, to make sure they’re doing what you want in a portfolio context.”
He also highlighted why the aggregate bond market, where volatility sits between three and four per cent and offers returns between two and four per cent, should be especially appealing to investors. “When income volatility is around one per cent, it means income can offset one standard deviation price shuffle. That’s something to consider in a benchmark. It’s about compounding faster than the price level — that’s what you want your manager to do for you.”
In addition to identifying and analyzing beta, Moore said managers need to focus on asset allocation to create an all-weather portfolio.
“This is a multi-sector product — it’s not pure emerging markets or high-yield bonds. It should have that kind of volatility and tail. You want your portfolio to seek yield and low return, but you want something with low correlation to stocks and probably liquid enough that when there’s an obvious event like 2020, you can liquidate.”