Broad diversification in the fixed interest segment of portfolios is vital in order to minimise risk and ensure it works as a proper defensive mechanism in falling markets, according to the head of fixed interest with a major index fund manager.
“The Australian bond market is very, very small by comparison to the broader market and I think it is important getting exposure to other bond markets,” Vanguard head of fixed interest and investment solutions Roger McIntosh said.
“[By incorporating other bond markets] what you are effectively doing is diversifying risk. If the annualised volatility of returns of the Australian fixed interest market was just under 3 per cent and global bonds were around the same, if you combined the two together the total risk of the two combined is lower,” he said.
An additional argument for diversification was the fact that over a 10-year period, when comparing domestic and international government fixed interest instruments and credit market fixed interest instruments, no single category consistently outperformed its peers, McIntosh said.
Investors and advisers also had to be careful when selecting fixed interest managers as well, as their strategies may fail to provide the required consistency over a medium to long-term investment horizon.
Mercer data used by Vanguard to compare bond manager performance over two separate but consecutive three-year periods to August 2006 and August 2009 showed the best performing manager in the first period was ranked 41st in the second period.
“Invariably managers can’t maintain consistency of returns,” McIntosh said.
In this light it was imperative investors did not select managers on the basis of past returns, he said.
One strategy that can provide an effective fixed interest outcome is indexing, according to McIntosh.
“That’s because opportunities for outperformance are very limited. The cross section for dispersion of returns just isn’t there.”
