Fixed income investors hungry for yield are increasingly turning to hybrid products and emerging markets, according to Lonsec.
The 2015 Lonsec Fixed Income Sector Review noted that the global hunt for yield has been a strong theme for several years.
In particular, Lonsec noted increased comfort among investors with the newer 'equity like' hybrids.
Contingent/convertible hybrids, known as 'CoCos', convert from bonds into stocks when they reach a certain price.
Along with hybrids, there is also broader general acceptance of emerging market country bonds, said the report.
"The lines between emerging and developed markets have become increasingly blurred," Lonsec noted.
Overall, the report found that traditional bond funds outperformed their more credit-intensive counterparts in 2014.
"Australian fixed interest managers, after a strong 2013, generally had a tougher year; while global fixed interest, after a dismal 2013, was the top performer within the fixed income universe with seven out of 10 managers outperforming the Lonsec benchmark," said the report.
Diversified fixed interest managers, on the other hand, lagged both Australian and global benchmarks, said Lonsec senior investment analyst Libby Newman.
"This was pretty much a reversal of 2013. Managers that changed tack quickly were able to benefit," Ms Newman said.
"Fixed income investing has been rewarding for a generation and has served investors well as a ballast for growth assets. However, what worked in the past seems less suitable for the world ahead – be it a Japanese-style sustained low bond yield or a reversal of the 20-year bond rally," she said.
The changing fixed interest environment has seen the rise of unconstrained or absolute return bond funds, Ms Newman said.
"Unconstrained investing, which is primarily focused on delivering a positive absolute return, requires deep research commitment, sophisticated analytical tools and the integration of risk management at all stages," she said.
"The real appeal lies in the ability of unconstrained funds to deliver investor nirvana – a positive return when yields rise, mostly by being short duration and long credit risk; but also being long duration when yields fall – as they invariably do in risk off periods – 2014 has been testament to that," Ms Newman said.
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