Fischer Francis Trees and Watts (FFTW) said while investors viewed fixed income products as safer, rising rates would require that prices fell for fixed income securities with positive duration.
“Most investors benchmark their fixed income portfolios against an index that has positive duration.”
That would mean that for the forseeable future, even if they outperform a market bond consistently, the total return in a rising interest rate environment could be negative.
Instead of relative returns, those investors should look to absolute returns, FFTW said.
“In a relative return strategy, if the manager has no opinion about an asset or asset class, then it will be held at benchmark weight. By contrast, an absolute return manager will not hold the asset or asset class at all.”
Relative returns would also see investors holding securities that they had a negative opinion on, FFTW said. “If the manager wants to express a negative opinion on an asset or asset class, the alternatives are to underweight the index or to take an off-index position. Neither option is costless… by contrast an absolute return manager is able to freely express options, mostly likely via derivatives.”
An absolute return opportunity set might include governments, structured securities, corporate credit, emerging markets and currencies, they said.
“The absolute return strategy is not compelled to follow the sector allocations of the benchmark. Instead it can be allocated according to opportunities.”
FFTW said an investor who invested in a US Core strategy and moved away from 100% in the Barclays US Aggregate Index into a combination including 25% or 50% of an absolute return strategy would have reduced volatility a lot since 2006 but returns only marginally.
FFTW said its absolute return composite had been positive in six of the 10 months of largest interest rate rises since 2007 but the Barclays US Aggregate was positive only twice.
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