Bavarian fund buyers move back into absolute return

Even though they continue to have issues with absolute return funds, fund selectors in Munich feel forced to move back into the asset class.

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PA Europe

When our researcher visited the Bavarian capital a year ago, local investors had largely disengaged from absolute return funds, as returns had been disappointing. They also had their questions about the transparency of such products. Despite the fact that these two objections still hold a year on, perhaps even more strongly when it comes to the performance issue, Munich’s fund buyers have decided to give it another go: some 45% of them plan to increase exposure in the next 12 months.

So what has made them change their mind? It would perhaps be a bit harsh to say it’s been desperation, but fact is that German bond yields have plunged into over the past year, with the 10-year Bund now at -0.12%.

Therefore, Munich’s investors feel they are left no choice but to replace part of their fixed income portfolio with absolute return funds. They are not, however, quite sure how they will exactly do that as absolute return funds that deliver on their promises remain hard to find.

Long/short equity funds are the most popular option, though they are also among the strategies that have disappointed most this year due to subdued volatility and mean-reversion trades in several asset classes. Long/short equity funds are down over 6% on average year-to-date. Interviewees, however, are betting volatility will return, providing more benign conditions for long/short equity managers to outperform.  

Bond loyalty

Fixed income remains a core component of Bavarian investors’ portfolios though. Quite a few of them don’t have a big problem with holding negative yielding bonds. The problem of negative yields  is exacerbated by interviewees’ preference for short-duration bonds. To mitigate this, they recognise increasing allocation to lower-rated bonds like those from peripheral Eurozone countries is a necessity.

However, Bavarian investors and their conservative clients have a rather low credit risk tolerance. There is therefore only limited interest in high yield bonds. US high-yield is dismissed as too reliant on commodity-related companies, but more solid European high-yield bonds don’t have a lot of fans either.

 

 

The only fixed income category Bavaria’s investors are seeking more exposure to is emerging market debt. While emerging market countries are increasingly issuing debt in local currency rather than in dollars, the former remains too risky to even consider for most investors in Munich. They believe the currency risk component simply makes it too volatile an investment. Hard currency corporate bonds are therefore their preferred choice. Even conservative Bavarian investors appreciate they have to take some risk to find yield these days. In case absolute return funds continue to not deliver any returns, yield will come from emerging markets, they reckon.