“It’s about how much money you have in equities versus fixed interest, for example.” Bowerman says that no more than half a century ago it was more common for portfolios to be invested 70 per cent in fixed interest securities and 30 per cent in equities. Since then the position has reversed. That decision, far more than manager selection or those managers’ stock selections, has driven portfolio returns, both good and, more recently, bad. Bowerman says that if asset allocation is the primary driver of portfolio returns, there’s a strong case to be made for index funds management, at two levels.
First, there’s strong evidence that so-called “active” fund managers are really quasi-index funds anyway; their performance is closely correlated to index funds. And second, since outperforming a benchmark is apparently difficult (either because of a manager’s choice to hug an index or because of the fundamental nature of markets), paying fees for active funds management is not likely to produce superior performance. But there’s disagreement over the role of indexing. Simon Doyle, head of fixed interest and multi- asset for Schroder Investment Management, says index investors will “clearly need to increase their exposures to government bonds to remain in-line with benchmark”.
“In some ways this is a relatively irrational investment decision – increasing exposure to a market after it has rallied hard and at a point in time when supply is about to explode,” he says. “On this basis, risk is being assessed relative to benchmark – not from the perspective of what matters to investors. “A more rational approach is to construct a fixed income portfolio which is more focused on the investment outcome delivered to the investor rather than the benchmark. In this regard, understanding the underlying investment characteristics of the investment universe – government bonds, credit, cash, et cetera – and constructing a portfolio that matches these characteristics with the investors’ objectives, makes more sense.” Doyle says.
Schroder uses a “core-plus” approach, which has “a core exposure to the UBS Composite Bond Index with the ‘plus’ coming from a wide variety of return-enhancing and risk-reducing strategies across the fixed income universe”. These strategies include: exposing the fund to different types of credit; interest rate strategies; and regional strategies. Doyle says the objective is to “achieve a return 1 to 1.5 per cent above benchmark but with lower than index volatility”.
Darren Langer, head of portfolio management for Tyndall Investment Management, says: “We really have not changed the way we manage fixed interest. “We’ve seen since the late 90s through most of the 2000s, that credit has become a much bigger part of the indices. That doesn’t change the way we manage things; we still tend to pick things from the more conservative side of things. “What we think has been the biggest problem in the last 10 years was everyone expected 100 per cent of their portfolio to behave as if it were invested in equities.”
Langer says the role of fixed interest as a defensive asset class, diversifying the risk associated with equity and equity-type markets, was too often overlooked. “I didn’t classify a lot of the retail product out there as being traditional fixed interest; a lot of it was highly structured, highly leveraged. While a lot of them didn’t look like options, they were options. They are not good for individual investors. They are not things that mums and dads – the people talking to financial planners – can tell apart for themselves.”
Langer says that when equity markets are producing “returns of 10, 15, 20-plus per cent, people forget that’s not sustainable”. But the expectation of returns from the equity portion of a portfolio has a sort of domino effect on what investors then tend to expect from even the defensive portion of a portfolio. “It’s a matter of balance, and how much they want their clients’ portfolios to be able to weather a downturn,” Langer says. “It’s hard to say how much they should have; but what you want is something that’s going to protect you. “You do not need all the bells and whistles and heavily structured yields to get you all of that.
“A 10 per cent increase in bonds when equities have fallen 20 per cent isn’t bad protection. “It’s generally going to give you a return better than cash.” “One of the things financial planners don’t do is understand fixed interest well, and I think that’s partly the fund managers’ fault over the years,” Langer says. He has spent “plenty of time” talking to planners and appearing at seminars to talk about equities, but “in fixed interest I can count on one hand how many times I have done a seminar or something like that”, he says.
All investors in fixed interest products need to “learn how to estimate what is reasonable, and not get caught up in some of these fraudulent schemes”, Langer says. “Product-wise, we are trying to get a lot of feedback on what people want – but it’s not always clear that everyone knows what they want,” he says. “We are not trying to give them 15 to 20 per cent return every year; we’re trying to give them something that’s reasonable when their growth assets aren’t doing so well.”
The way that investors access fixed interest markets clearly has a great bearing on their eventual investment outcome. As Zenith notes in its fixed interest sector report, government-bond funds performed quite differently from credit funds during 2008. S&P says: “Unfortunately for the financial planning community, not all products are alike. Bond funds are not cash funds, which are not enhanced cash funds, which in turn are not income/high yield income funds.” The following table outlines the different funds’ “basic architecture”.
