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Future-proof your fixed income portfolios – Part 2 of 3

Besides higher-yielding bonds, investing in liquid alternatives is another way to future-proof bond portfolios. But such ‘absolute return’ funds bring potential benefits as well as drawbacks.


PA Europe

In part one of this article series dedicated to strategic fixed income allocation, we saw that investors are reducing the duration of their portfolios and increasing allocation to higher-yielding bonds. But there’s more to be done to be able to sustain returns over the long term. Absolute return funds are one way to address the challenges posed by record-low yields.

Absolute return funds have remained stubbornly popular over the past three years or so, even though most funds in this category have posted disappointing returns and employ investment strategies with varying degrees of opacity.  

Benefit of the doubt

Wealth managers in the Netherlands and elsewhere in Europe keep giving absolute return products the benefit of the doubt. Across Europe, almost half of fund buyers plan to increase their allocation to absolute return funds over the next 12 months. In the past four years, investors across the continent have chipped in a phenomenal amount of €206bn into the asset class.  

The reason for this is obvious: as bond yields continue to edge lower, the urge to diversify away from duration risk becomes stronger and the hunt for yield intensifies. But, admittedly, most absolute return funds haven’t provided any yield after costs over the past two years. And they involve ceding control over part of the asset allocation, a difficult concession for many investors. So why are these funds still popular?

“It’s because they sell the promise [of uncorrelated returns],” says Jeroen Vetter, an industry consultant. When the long-awaited bond bear market eventually kicks in, absolute return funds will stand their ground, so goes the logic. It’s a commonly held belief among investors that long/short funds have only disappointed this year because there has been a lack of volatility. But the problem runs deeper, believes Vetter, at least when it comes to absolute return fixed income.