Persistently low government bond yields, the continuing threat of inflation, interest rate decreases and volatile sharemarkets have led investors to embrace an absolute return fixed interest investment approach, according to Morningstar’s Fixed Income Sector Wrap-Up.
A majority of market participants have traditionally focused on returns relative to asset class benchmarks, but an absolute return mentality has gained strength in most asset classes – and in many countries.
The United States, for example, has seen an explosion of fund launches and meaningful assets growth in the area.
“These strategies, which are wide-ranging and heterogeneous, introduce meaningful risks and may not be appropriate for many investors,” Morningstar said. “For some, however, they offer a reasonable way of trying to protect accumulated capital.
“These funds have not yet achieved substantial traction in terms of asset flows, and the trend smacks of marketing gimmickry. However, the pervasiveness of the idea, combined with the real market risks that spawned it, means that these strategies warrant closer investigation.”
Investors in the accumulation period are likely to be able to withstand losses volatility from fixed income and could benefit from the diversification provided by using this sort of strategy.
But investors in or nearing the drawdown phase are likely to have portfolios more sensitive to interest rate movements.
“They may be living off the income their investments provide or, at the very least, primarily concerned with preserving their wealth. These investors could benefit from moving a meaningful portion of their defensive allocation into a more flexible, interest rate defensive strategy which could diversify their portfolio, boost income, and guard against bond yield rises,” Morningstar said.
The firm stressed, however, that any allocation should be part of an investor’s defensive portfolio because the strategies are mostly designed for capital preservation, with income generation a secondary goal.
